He who loses money, loses much; He who loses a friend, loses much more; He who loses faith, loses all.”
Eleanor Roosevelt
Depending on your perspective, a look back on 2022 will evoke different feelings. For Ukrainians, it was an annus horribilis, an expression made famous by the late Queen Elizabeth II. It was also a challenging year for stock and bond investors. On the brighter side, sports enthusiasts celebrated Olympic performances and the World Cup competition. Fingers crossed, 2022 will be remembered as the last of the worst of COVID.
At the start of the year, everyone was eager for a return to normal. Capital markets seemed poised for a period of transition, despite some uncertainties. COVID restrictions were fading in the rearview mirror, along with the need for fiscal and monetary supports to counter the pandemic’s devastating impact.
Then the first quarter put the brakes on everything. We saw runaway inflation, a war in Europe, global sanctions on Russia, China’s bungled COVID policies, and a puzzling no-show from workers. Supply-chain chaos, rapidly rising interest rates, spiking food and commodity prices, and stark reassessments of geopolitical risk became the head-spinning new reality.
Of course, stock markets swooned. Inflation ballooned into a cost-of-living crisis. Central banks and politicians were forced to respond. The Bank of Canada (BoC) was first with a rate hike in March, followed by the U.S. Federal Reserve (the Fed). At the end of 2022, every major central bank except China’s was tightening. The net result was the worst year on record for the Canadian bond market and a crumpling of the S&P 500 and S&P/TSX after they crested at all-time peaks early in the year. In 150 years of U.S. data, 2022 marks the worst combined result for stocks and bonds – a rare tandem horrible year.
Capital markets began guessing just how high interest rates and bond yields would need to go in order to tame inflation. A potential global recession dominated discussions.
These crosscurrents were active all year. Signs that inflation was cooling sent stock and bond prices higher, only to have central bankers warn that they weren’t done raising rates. Retreating commodity prices brought glimmers of hope. Global supply chains untangled, allowing companies to resume business with whatever additional workers they could find (the great retirement is real). Pent-up savings kept consumers spending, allowing corporations to pass along price increases that defended their profit margins. Corporations delivered better-than-expected earnings, which supported stock markets. Still, all of this couldn’t overcome the negativity driven by soaring inflation, higher interest rates, less easy money, slowing growth and increased geopolitical tensions.
Global inflation is showing signs that it may have peaked and is beginning a slow retreat, but services, wage growth, and housing costs remain strong. The year looked like it might end with a typical Santa Claus rally until global central bankers began acting “Grinchy.” Markets were soft in December thanks to central bankers’ pledges to raise rates until inflation and wage growth fall back into line. They warned that markets should brace for “higher for longer” into 2023.
The bond market doesn’t entirely buy this story, however. History tells us that aggressive tightening cycles tend to swiftly reverse and the track record of central banks following through on their guidance isn’t good. Recall that the Fed predicted 2022 would end with a policy rate of 1.5% (it sits at 4.5%), a reminder to take with a grain of salt current Fed guidance that we can expect a 2023 rate north of 5%.
The consensus view is that we’ll be in a recession in 2023. Although their opinions might be biased, U.S. Fed Chair Jerome Powell and Treasury Secretary Janet Yellen have said there is risk of a recession, but it’s not inevitable. In addition, the unbiased opinion of the stock market (to which we are ardent subscribers) is signalling some curious non-recessionary developments, with certain highly economically sensitive sectors outperforming. And if higher borrowing costs are going to tank the U.S. housing market, it is also curious that shares of large U.S. homebuilders are outperforming as well.
For our take on what will happen in 2023 (spoiler alert, we don't expect a recession), see our 2023 Market Outlook: The End of Free Everything?.
Canada – Barely avoided the bear
In 2022, the S&P/TSX Composite was one of the rare global stock markets to avoid an outright bear market (defined as a decline of 20% or more from the prior peak). Peak-to-trough declines ranged from -17.5% for the TSX to -41.7% for the MSCI Emerging Markets Index. For December, the TSX fell 5.2%, down 8.7% for 2022. Energy was a clear standout, climbing 24.4% for the year even though oil prices ended 2022 little changed. West Texas Intermediate oil rose 6.7% on the year to US$80.26 a barrel. For 2022, the loonie fell 6.8% on broad-based U.S. dollar strength, closing at US$0.738, or C$1.36.
Canada’s inflation rate fell to 6.8% in November, off its June peak of 8.1%. In December, the Bank of Canada raised the overnight rate to 4.25%, its seventh rate hike in 2022, capping off a year when it tightened by 400 basis points. Against this backdrop of inflation and rate-hiking, bond yields rose with high volatility. For the year, Government of Canada 2-year bond yields rose from 0.95% to 4.05%, while 10-year yields more than doubled from 1.42% to 3.30%. In December, the FTSE Canada Universe Bond Index fell -1.7% to end the year down 11.7%. Although it’s cold comfort, the Canadian bond market outperformed its global counterparts. U.S., European and Emerging Market bonds saw returns up to 7% worse than Canada’s.
United States – A sloth of bears
All four major U.S. equity market indices were battered by bear markets in 2022. Peak-to-trough declines for the S&P 500, Dow Jones Industrials, NASDAQ and Russell 2000 ranged from -36.4% for the tech-heavy NASDAQ, to -21.9% for Dow Jones Industrials. In December, the S&P 500 fell 5.9% to end the year down 19.4%, above its peak decline of -25.4% in mid-October.
Heading into 2022, U.S. markets topped the list of equity markets that were overvalued and complacent toward risk. A lot of work has been done to excise this rot. Companies whose shares rose exorbitantly based solely on dreams that a pandemic would forever change their fortunes have been hit with spectacular declines. Share prices of many companies ramped up hundreds of percentage points (thousands in some cases) from March 2020 only to suffer a complete reversal of fortune by the end of 2022.
They aren’t all just pandemic fads or meme stocks, either. The Dow and S&P 500 peaked on January 3, 2022, the same day Apple became the first company worth more than US$3 trillion. Apple is a great company, but its shares are down 27% on the year. Amazon, another great company, has a share price today of US$84, little changed from its pre-pandemic price yet down from its mid-2021 peak of US$186. These adjustments also reflect a shift away from an environment of low interest rates. In 2022, the Fed hiked interest rates by 425 basis points and the U.S. 10-year Treasury yield more than doubled from 1.42% to 3.87%.
Europe – Bearing the brunt
Russia’s invasion of Ukraine sparked a humanitarian and energy crisis, creating misery for the Ukrainian people that spilled over into most of Europe. Nevertheless, European equity markets fared better in local currency on the year versus many of their global counterparts. The numbers are 6% to 10% worse after the declining euro and pound sterling are considered.
European economies, and particularly their export-heavy stock markets, are very sensitive to global growth. Expectations for a global slowdown are weighing on the markets. With central banks hiking rates to tackle raging inflation, European bond yields rose sharply. Yields are below North America’s, but because they started from lower levels they delivered more severe losses for European bond investors. The Bloomberg Pan-European Aggregate Bond Index fell 18.9% for the year.
Equity market results for December and the year are as follows: Euro Stoxx 50, -4.3% and -11.7%; German Dax, -3.3% and -12.4%; and Britain’s FTSE, -1.6% and 0.9%.
Asia – Bouncing bears
Chinese stocks, which had been in a deep bear market, bottomed in October 2022 when the MSCI China Index fell 63% from its early 2021 high. Beijing believed it had avoided the worst of COVID and was early to tighten monetary policy. Meanwhile, a meltdown in the real estate and technology sectors that began in late 2020 continued into a third year. These problems escalated when COVID outmanoeuvered strict lockdown measures and came roaring back. To deal with a slowing economy, China bucked the global trend and eased monetary policy – with minimum impact. However, redoubled efforts to stimulate the economy and an abrupt shift away from COVID restrictions turned the tide for Chinese equities, prompting a sharp 35% year-end rally off their October low.
Japanese equities were a source of relative calm in 2022. The Nikkei 225 experienced multiple swings greater than plus-or-minus 10% but managed to avoid bear-market territory. The currency was the main attraction for Japanese assets as the Bank of Japan (BoJ) stuck to its easy monetary policy. The yen fell 23% against the greenback before rebounding 15% late in the year on a hint that the BoJ might tighten monetary policy.
Returns for December and the year are as follows: MSCI China Equity Index, 5.2%, and -23.5%; Nikkei 225 Stock Index, -6.7%, and -9.4%.
Our strategy – Balanced
Our asset-mix strategy in 2022 generally involved a slight overweight to equities and underweight to fixed income. We trimmed the degree of overweight to North American stocks early in the year, reduced our cash underweights, and then sold international equities in the third quarter, using the proceeds to reduce our fixed-income underweight.
Stocks and bonds sunk in tandem declines, so there were few places to hide. Other notable asset-mix trades for our core models included a June rebalancing of our underweight exposure to emerging markets. As stock markets wilted in the summer, we topped up the equity exposure that had drifted away from our overweight target, namely U.S. equities.
We believe it’s still appropriate to stick reasonably close to our long-term strategic benchmarks – with some prudent tactical tweaks. In turbulent times, a well-balanced, solid foundation provides a position of strength for investors.
In our bond portfolios, we are reinvesting the coupon income and maturing securities to achieve higher yields. If there is a recession, we believe our bond positions will supply a level of safety.
We remain slightly overweight equities. Our geographic alignments reflect where we see the best risk-adjusted opportunities. We are underweight international developed markets (primarily Europe and Japan) and overweight to North American equities.
The last word – Giving thanks
Reflecting on 2022, an annus horribilis, it is impossible to understate the horror of what is happening in Ukraine; everything else pales in comparison.
We remain confident that capitalism and its conduits, the capital markets, can – and will – work through whatever financial obstacles they might face, as they always have. We are confidently hopeful, too, that humanity can overcome whatever trials and tribulations lie ahead.
To you, our clients, we offer heartfelt thanks for your faith and trust in us, allowing us the privilege of working on your behalf. Our responsibility to you is always front of mind.
We work in a privileged vocation but remain humbly aware that the capital markets affect a real economy in which many people are struggling.
In choosing a path, our goal is to remain objective. While we often create set strategies and take decisive actions, we also know that hubris doesn’t pay. Open to opportunities, we forge ahead and strive to remain flexible in our choices, avoiding the pitfalls of dogmatism.
The words of Eleanor Roosevelt remind us that although money was lost in 2022, it can be remade. Friends are irreplaceable, and faith takes courage.
Please contact your Investment Counsellor if you have any questions or would like to discuss your investments.
Information contained in this publication is based on sources such as issuer reports, statistical services and industry communications, which we believe are reliable but are not represented as accurate or complete. Opinions expressed in this publication are current opinions only and are subject to change. BMO Private Wealth accepts no liability whatsoever for any loss arising from any use of this commentary or its contents. The information, opinions, estimates, projections and other materials contained herein are not to be construed as an offer to sell, a solicitation for or an offer to buy, any products or services referenced herein (including, without limitation, any commodities, securities or other financial instruments), nor shall such information, opinions, estimates, projections and other materials be considered as investment advice, tax advice, a recommendation to enter into any transaction or an assurance or guarantee as to the expected results of any transaction.
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