Market Review of 2022
2022 started as a hopeful year, as the global economy continues to recovers from the ravages of the COVID-19 pandemic, with many countries still having closed borders, as the newly mutated Omicron variant started their rampage around the world. The stock market was optimistic with the stock market reaching a new high in Dec 2021, and all of that came crashing down as Russia unexpectedly invaded Ukraine. The invasion threw a brick into a fragile global recovery, creating sharp disruptions in the logistic and commodities markets, leading to a supply shock in many essential commodities, such as wheat and oil. This caused inflation to explode out of control with US reaching a level not seen since the 1980s.
The US central bank reacted quickly by raising interest rates from 0.25% to 4.5% by the end of 2022 in an effort to rein in inflation. This lead to a sea of red across almost all asset classes with little place to hide. Our portfolio took a beating in 2022, but we are not alone. There were few places for investors to hide as nearly every corner of the financial markets posted big losses. In addition to stocks spending most of the year in a bear market, many parts of the bond market posted their biggest losses in history, meaning fixed income failed to live up to its traditional role of providing a cushion to ride out the decline in equities.
Bonds had their worst year in modern history as the average US Bond prices fell 12.9% as compared to prior calendar-year losses which had never exceeded 2%. Only a very narrow section of the stock market, truly defensive names such as stable, high-dividend payers, offered shelter from the storm. The Singapore stock market, well known for it's stable and defensive companies, outperformed the rest of the market.
Gold, which is the traditional hedge for inflation, did not perform its traditional role and even saw losses despite the expectation that a record inflationary pressure around the world will push its price up to new heights. Instead of fleeing to Gold, investors fled to US Dollar instead.
The fourth quarter brought some relief, as inflation started to come down and most countries with the exception of China had opened up their borders. However, the improvement was not enough to have changed the outcome: 2022 was a year for the record books, and it is not in a good way.
Having said that, with great risk, comes great opportunities, and history has shown that investors who are able to capitalize on times of great fear, will benefit the most when the danger is over.
Investment Outlook and Themes for 2023
The geopolitical and economic drivers that lead to a miserable year in 2022 will be same drivers for 2023.
Russia-Ukraine War
The biggest war on the European continent since WWII threw a wrench into the global recovery. The war has lasted nearly for 1 year and the initial disruption has been smoothed over since than. Many European economies which were dependent on Russian oil and gas, have found new supplies and has cut their reliance. However, the cost comes at higher energy cost, which lead to higher inflation in Europe, as compared to other parts of the developed world. Ukraine has declared that they will be able to end the war in 2023 by taking back the Crimea peninsula, with the support of the western military. The possibility of that happening still remains to be seen, as Russia has shown no signs of backing down, and is looking to buff up their military with new conscription and weapon imports from North Korea and Iran. If the war can end in 2023, this will lead to a huge jolt in sentiments to the global stock market. If it doesn't, the stock market will not be affected too much as most of the developed economies has adjusted to the supply shock that comes with the war.
Inflation Cools - How Fast & How Much?
By the 4th quarter of 2022, inflation numbers have fallen from double digits to high single digits. This allows the US central bank to lower the rate of the rise from 0.75% to 0.5%, with a target of 5% interest rate. One of the reason for the depressing stock market in 2022, despite healthy economic growth around the world, is due to the uncertainty of how high the interest rates will go, as the US central bank is committed to combat inflation as long as it takes. With inflation starting to stabilize, the market will be watching the US central bank intently, to see if they intent to end the hike rise early and when they will end the rise. Given that China is opening up and the world is reverting back to the pre-pandemic norms, inflation has a high chance to fall below the 5% mark and that will give the stock market a huge spur in confidence.
China Opening Up and Geopolitical Risk
The series of protest and riots in Nov 2022, has prompted the China government to abandon their zero COVID shutdown and re-opening the doors to the rest of the world. As the largest manufacturing and shipping hub in the world, COVID shutdowns have disrupted a lot of supply chains, which contributed to the inflation problem. With the impeding full opening of China economy, it will give a jolt in the world's economy as the disruptions from the zero COVID policies become a thing in the past. In recent days, China's foreign ambassadors have been reaching out to countries with gestures of goodwill and trade offers. However, due to the wolf warrior tactics that China has been pursuing and deep mistrust by western economies, geo political tensions are expected to persist similar to the trade war engaged between US and China before the pandemic.
Portfolio Review 2022 and Investment Strategy for 2023
2022 has been a challenging year and the initial hypothesis of a mild to moderate inflationary environment with a measured rate rise, along with continual economical recovery was overturned by the sudden outbreak of the Russian-Ukraine war. The portfolio has been helped by the strong rise in USD and a bond allocation that out-performed the traditional long term bonds. However, the technology sector did not see the realized gains from the recovery, as a combination of factors such as slowing revenue rise, as lesser people used less technology due to the re-opening of the global economy and the sharp rise in interest rates gave technology stocks a double whammy, as capital became more expensive for fast growing, loss making technological stocks.
The cash portfolio lost -19.1% for Cash portfolio, -27% for CPF-IS and -19.1% for SRS. The CPF-IS portfolio performed much worse than the other 2 portfolios was due to the US fund has a higher the proportionate amount of technology stocks in its fund. The source of its outstanding returns in 2020, when the portfolio returned 25% now became its curse.
While the current environment poses its own unique challenges like red-hot inflation and rapidly rising interest rates, there's a likelihood that, based on history alone, the technology could be set for a bumper 2023.
That's because the index has delivered an average return of 51% in the first positive year following a loss, and given the rarity of consecutive declines, the odds suggest 2023 is likely to be green. But investors will need to see economic headwinds subside, and there are already some early signs that's happening.
The portfolio will see a substantial rally going forward as both equities and bonds will recover from the losses of 2022. The question is, what can we do to make the recovery go faster, and start generating profit again. This is where the proposed adjustment of the portfolio will help in the recovery.
The general allocation is 70% in equities and 30% in bonds. We will be moving to a 80% equity and 10% bond allocation. Within the equity allocation, Emerging Market allocation will increase from 10% to 20%, revising our previous stance of avoiding China, as the opening up of the Chinese economy will lift the general sentiments in the Emerging Market sector.
Other plans in the near future is to move the short duration bonds to a more traditional long duration bond fund, to take advantage of the higher interest rates and to lock it in for a longer duration of 10 years. Technology stock which has been beaten down, is also a possible candidate in the near future to increase the weightage thanks to cost cutting measures and a fairer valuation after a brutal 50% fall in 2022.
Investing in stock market is like a fisherman, navigating through the open sea. There will be times when the ship is stuck in a storm, where careful maneuvering and patience to wait for the weather to clear and the sea to be calm, and the harvest of plentiful fish will be there for the taking!
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