December 2022

December Investment Summary

Well, I think we are all glad that 2022 is behind us. A poor December made sure 2022 was one of the worst years ever for both equities and fixed income! Major markets around the world were down anywhere from 1% to 8.9% on the month.

The tech-heavy NASDAQ was the worst, closing the month down over 8% and over 33% on the year. This doesn’t tell the full story as the large-cap tech darlings, which helped investors reap big gains in 2021, were simply awful performers in 2022. Apple was down 26.8%, Amazon was down 49.6%, Facebook (Meta) was down 64.2%, Alphabet (Google) dropped 39%, and Tesla fell a whopping 65%! It isn’t clear that the derating of these names is finished either - as central banks continue to hike interest rates, then those future cash flows become worthless in today’s money.

The major global central banks – US Federal Reserve (Fed), European Central Bank (ECB), and Bank of England (BoE) - all emphasised, at their final meetings of the year in mid-December, their determination to bring inflation back to their respective 2% target.

The three central banks hiked overnight rates by 50 basis points whilst stressing that more hikes were coming in 2023. Furthermore, all three suggested that rates would have to remain high, or higher than we have been used to for a considerable time, to ensure inflation returns to target. They also argued that slower growth was required and that a recession, while not their goal, could not be ruled out as an outcome. The ECB also announced that they planned to begin shrinking their balance sheet in March 2023. So, now we have another central bank no longer buying bonds but in fact effectively selling them.

Even the Bank of Japan made a move. They modestly adjusted the top yield at which they will allow ten-year Japanese government bonds (JGBs) to trade from the previous cap of 25 basis points to 50 basis points. They denied this was a volte-face and set out plans to increase the amount of JGBs they will purchase each month to ¥9 trillion from ¥7.3 trillion (roughly $68 billion from $55 billion). The markets didn’t fully believe them as the yen rallied in the foreign exchange markets and yields around the world jumped higher on the news. Japan is a major exporter of capital and Japanese investors have been pouring money overseas to obtain higher yields in an attempt to protect themselves from the persistently weakening yen. The markets are beginning to sniff out that this process may reverse. The question is simply when. The current Governor of the Bank of Japan, Haruhiko Kuroda, is scheduled to retire in April of this year. Given that inflation in Japan is now at a thirty-year high level of nearly 4%, a policy change is likely.

China finally officially abandoned its Zero-Covid Policy. Initially, markets took it well, particularly the Chinese equity market, as the rumours around the policy change swirled through the markets. The actual impact is proving to be very messy, with surging infections, hospitalisations and deaths, and a medical system unable to cope with the situation. The Chinese government is being stingy with details, but we can see activity plummeting as sick workers cannot go to work and people are fearful of going out and catching the virus. It will be a few months before the world feels some tangible benefit from the policy change.

This year is likely to be challenging as we adjust to the highest interest rates we have experienced over the past decade. But for those of us who have been around for a while, official interest rates of between 3-5% are not punitive. Businesses will survive and many will thrive. A recession, of course, is possible, but a period of prolonged slow growth seems more likely. This will damage corporate earnings and that will weigh on equity prices. In this economic environment, it is important to own companies with pricing power and a strong market position to withstand this outcome.

Inflation does seem to have peaked and it is a question of how fast it gets back down to target. There is the possibility that central banks decide to accept a higher level of inflation than 2% or are willing to take longer to return inflation to their target, so perhaps they pause their rate hikes and hold rates in that 3%-5% range we have mentioned and let balance sheet shrinkage keep downward pressure on inflation.

In the near term, we continue to maintain a cautious and conservative approach. Capital markets will likely remain vulnerable and volatility is likely to persist. The upcoming earnings season should be watched closely as, in our view, earnings expectations haven’t begun to price in margin compression and the economic headwinds faced by a lot of consumers. Cash and short-term fixed- income securities offer a reasonable nominal yield whilst we wait for better opportunities to develop in equity markets.

Jeffrey Brummette

Chief Investment Strategist

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