2022 Review & 2023 Outlook
Review of 2022
If there is one word to describe the calendar year 2022, it would be volatile.
Markets largely moved in response to two macro variables: inflation and interest rates. It became clear early in the year that inflation was not in fact, transitory. Record-low employment, populations eager to spend after two years of intermittent lockdowns and pandemic-induced labour and shipping constraints created a perfect storm where demand exceeded supply. The Russia-Ukraine war only exacerbated these factors.
As a result, central banks across the globe rushed to increase interest rates to tame accelerating inflation. The Reserve Bank of Australia increased interest rates every month from May, bringing the cash rate from 0.10 per cent to 3.10 per cent. This had a profound impact on asset prices. The era of cheap money came to an end, with the majority of asset classes, including property, equities and fixed income, falling in value to incorporate a higher risk-free rate. The largest impact was felt in more speculative assets, such as cryptocurrency and high-growth yet profitless corporates, which had their valuations slashed.
Figure 1: Long-term asset returns. Source Morningstar
Both Australian bonds and equities, for just the third time in the past 50 years, decreased in value simultaneously. The benchmark S&P/ASX 200 index whipsawed back and forth in response to the two aforementioned macro variables, at one point falling 16 per cent before recovering to end the year down two per cent. Overweight exposures to mining and energy mitigated further falls. Domestic bonds recorded a rare down year, as higher interest rates made lower-yielding fixed income less attractive.
International portfolios required more patience than in previous years. Exposures to long-term secular trends that traded on higher valuations and won the pandemic years have been hurt. Even a strong US Dollar could not fully offset the fall in these assets. Exposure to technology and other related future industries fell away.
Higher rates drove the property market down by 5.3 per cent. Investors traditionally have default exposure in this sector (via their primary residence) and an average Australian share portfolio already has significant property exposure as it is. We also believe entering a debt-laden market was not the best choice for new money or a high-conviction bet.
Time in the market
After a year of volatility and negative performance, it’s normal to feel anxious about investments. But when we look out over a longer time frame, investing rewards the patient. Predicting short-term returns is difficult, if not impossible, and varies tremendously. The S&P/ASX 200 fell 39 per cent in 2008 however recorded a 41 per cent increase in 1993. Fortunately, history is on our side. Over the past thirty years, the Australian equity market has appreciated 9.6 per cent annually.
Figure 2: A timeline of bull and bear markets. Source Vanguard
Furthermore, periods of positive performance far outweigh negative years. According to Vanguard, there is a 79 per cent chance of a positive return in any given year. However over five years that probability increases to 92 per cent. Over ten years, the likelihood is 100 per cent.
It’s about time in the market, not timing the market.
Diversification still matters
Much has been written regarding the supposed end of the 60/40 equity-bond portfolio after the negative return in 2022. We think this is an overreaction where investors are failing to see the forest from the trees. The foundation of sound portfolio construction is to own a diversified number of assets to mitigate against idiosyncratic risks. When some assets don’t perform, ideally, other assets do. Historically bonds and equities have a low correlation and thus smooth out portfolio returns. Unfortunately, 2022 was one of the rare years when this did not occur.
Just as one sunny day doesn’t make a summer, one negative year of performance doesn’t mean we should abandon the balanced portfolio. The key takeaway is that over short-time periods, returns can vary. However, for those willing to look over 5, 10 or 20 years, both equities and bonds achieve positive returns (see Figure 1) and rarely decrease in value in the same calendar year. Past performance is no guarantee of future performance, but allowing markets to compound over time is a proven method of building wealth.
Turning to 2023
While the impact of higher interest rates will continue to have ripple effects throughout the economy, the fall in asset prices has set the stage for improved future returns. There is no alternative, colloquially termed the “TINA trade”, where investors were forced into higher risk asset classes in search of returns, is over. Investors are now able to earn a reasonable return on lower-risk assets such as term deposits.
Financial markets have largely priced in higher long-term interest rates. The key determinant moving forward will be corporate earnings, and how households cope with lower disposable incomes. From an international perspective, China looks to be emerging, rather quickly, from a three-year global hiatus. On the flip side, Europe and most likely the United States will enter some level of economic downturn.
We acknowledge 2022 was a difficult year. However, we remain confident in our view that investors with a long-term investment horizon will be rewarded from a diversified portfolio.
Important Notice:
Zuppe International Pty Ltd t/as Lawrance Private Wealth and The Financial Advice Shop (AFSL No. 532878).
General Advice Disclaimer:
The information and opinions within this document are of a general nature only and do not consider the particular needs or individual circumstances of investors. The Material does not constitute any investment recommendation or advice, nor does it constitute legal or taxation advice. Zuppe International Pty Ltd (ABN 12 628 405 952) (The Licensee) does not give any warranty, whether express or implied, as to the accuracy, reliability or otherwise of the information and opinions contained herein and to the maximum extent permissible by law, accepts no liability in contract, tort (including negligence) or otherwise for any loss or damages suffered as a result of reliance on such information or opinions. The Licensee does not endorse any third parties that may have provided information included in the Material.
Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown. Therefore, any stated figures should not be relied upon. The investment return and principal value of an investment will fluctuate so that an investor’s investments, when redeemed, may be worth more or less than their original cost.
