Making Sense of 2022
2022 will go down in the history books as “one of those years”. No one anticipated the extent of the “revaluation” that occurred across almost every asset class. Equally, no one expected the upward explosion of asset prices through the latter half of 2020 and all of 2021. So, as we look the coming year in the eye, the question on everyone’s mind is: “Will 2023 be better”?
We believe 2023 will be a settling year, possibly better than 2022, but still with some challenges. When times are uncertain, assets get priced lower (offering a better entry point, if we’re building wealth). Bravely participating on these occasions takes fortitude and it seldom feels comfortable.
The IMF is predicting global growth in 2023 of 2.9% and 3.1% in 2024 (and what now that China is re-open for business?). The leading financial & governing institutions of the world are optimistic.
Inflation is a problem. How big the problem was did not become apparent until midway through 2021. Central Banks pushed interest rates dramatically higher. By the end of 2022, there were encouraging signs that this was starting to work - the excesses were moderating; yet inflation remains well above all Central Bank targets. The challenge is, not to overshoot (or undershoot). Right now, it’s clear that interest rates are not coming down any time soon. We believe any immediate rises will be less extreme and rates may even hold. But a “higher” for “longer” mood will persist.
When we talk about “higher” interest rates, we’re usually referencing the OCR - the cash rate. But longer-term interest rates are also implicated and indeed, long-term interest rates greatly influence the value of long-term investments – including the value of housing and businesses (shares).
The yield on US 10-Year Gov’t Bonds rose 557% (from 0.54%pa to 3.55%pa) between March 2020 and January 2023 (just 34 months). It was the biggest and fastest change in 230 years!
By comparison to the last inflationary period in recent history, between 1972 and 1982 the yield on US 10-Year Gov’t Bonds rose 141% (but this was over 120 months!). In January 1972, 10-year Gov’t bonds paid 6.00%pa. By January 1982, that interest rate had risen to 14.50%pa. History records 1982 as the all-time high for US interest rates, and from that year onward, the overall trajectory for interest rates was down (reaching their historical low in March 2020 of just 0.54%).
The 1970’s & early 80’s was a period in US economic history seen as somewhat dark and recessionary. That “correction” took 120 months (10+ years)! We’ve just endured five times that trauma in just 34 months! If the peak of interest rates is near, things should begin to improve from here.
Encouragingly, long-term treasury yields are now higher than most times in the last twenty years. Could they go higher? Sure… Will they? Hard to say! Never has the world had such levels of debt and, if interest rates get too high, how then is the interest serviced - let alone the principal repaid?
Inflation has been so stubbornly low for many decades and Governments have freely printed money, without inflationary effect. We are at the crossroad of many interlocking sequences. We think we’re near the top of this cycle. If so, this time should bode well for smoother investing, given the risk-free rate (RFR) is now 3-5%pa, we might reasonably expect that modestly riskier assets should therefore deliver returns of between 6.50% & 8.50%pa (3% over the RFR).
In summary, there has been a re-set. Evidence to the cause and effect of excess is everywhere. With 20/20 hindsight, it’s obvious that gambling assets with no backing (ie; crypto), digital art that can be copied exponentially (NFT’s), or the number of Uber drivers offering hot stock tips… these are signals of excess (no offence Uber or digital artists). Prudent investors are always discerning because, through all the insanity, there are always exciting and legitimate businesses in which to invest.
The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client.