Quarterly Economic Commentary Dec 2022

So long and good riddance to 2022.  War, inflation, rising interest rates, and economic bottlenecks led to poor returns in most asset classes. In fact, 2022 was unusual in the sense that equities and bonds both fell simultaneously by large amounts. Usually, bonds act as a safe haven when equity markets fall.  As a result, a balanced 50/50 portfolio of global stocks and bonds had its worst year for nearly a century (Figure 1).

In contrast, asset classes that offer inflation resilience such as infrastructure, as well as value stocks, select alternative investments and short-term credit, fared much better. Our portfolios have been positioned for just such an event, and as such performed relatively well in the context of the large market declines.

Markets had to adjust to interest rates returning to more normal levels, and large cap growth-stocks (such as Meta and Tesla), which had led the market on the upside, suffered much larger declines than the overall market.  Purely speculative investments, such as digital currencies and NFT tokens, were harder hit still, with some suffering complete capital loss.  These type of adjustments – unfortunately – occur every cycle as speculative excesses are worked through (or, less euphemistically, as the naïve are parted from their money).  Closer to home, we also saw residential property prices begin to fall - ending the myth that they can only rise. 

Despite the seismic shift in interest rates and accompanying asset price declines, one welcome thing that we didn’t see over 2022 was the type of stresses associated with the global financial crisis of 2008.  Overall, the adjustment to higher rates globally has been fairly orderly, and, as discussed below, the silver lining is that we should now expect higher longer-term returns from most asset classes given higher cash rates and income yields on offer.  In our view, risks are now more evenly balanced.  Although economic growth is expected to be weak in 2023, with many economies likely to be in recession, this reduces the risk of core inflation rising higher still.  Energy prices are now clearly off their peak, in part due to the good luck of a warm European winter, which will reduce headline inflation rates.

Market roundup

Market performances are reported in Figure 1.  International shares on an NZD hedged basis rallied around 7% in Q4, but fell by around 2% in NZD terms.  The difference reflected that yet again currency volatility was a key feature of the quarter, with the NZD rallying as the shine came off the previously very strong USD. 

For calendar 2022 international equities declined around 11% in NZD terms, which was in line with the return from NZ equities.  In contrast, Australian equities with their resource focus performed relatively well.

Within global equities, value stocks also outperformed, returning around 2.6% over the quarter and 1.2% over the year in NZD terms.  However, higher risk small caps and emerging markets fared worse, returning around –12% and
–13.5% in 2022 respectively.

NZ and international investment grade bonds eked out small positive returns in the quarter bolstered by their now meaningful running yields.  The silver lining is that their cash yields, at +5%, are back to around “normal” pre-GFC levels.  This means that we can expect bonds to play their traditional diversification role should inflation and growth outturns be weaker than is currently being priced by the market.

International property stocks increased 4% in the quarter in NZD hedged terms, but performance over 2022 was very weak on both a hedged and unhedged basis as the office segment in particular priced in much lower tenancy demand.  In contrast, global infrastructure performed well once again, returning a handy 3% for calendar 2022 on an unhedged basis. 

The outlook ahead

No one can consistently forecast short-term market movements, though, as per our last update, we believe that inflation is the key economic determinant for markets to be able to form a bottom and to rally from current levels...

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