This year hasn’t been without its challenges, but are we closer to turning the corner?
With the end of the year in sight, we can only say that 2022 has been a challenging time in the stock market.
Returns have been well down versus the preceding couple years. If anything, the high base that the stock market entered the year has worked against investors, making it easier for traders to pivot to a risk-off approach and take profits after a remarkable bull run.
Nonetheless, whether you’re new to investing, or a seasoned professional that has experienced previous market downturns, this year has been defined by a number of issues that have proven tricky to navigate.
We’ve seen extensive volatility on account of ongoing uncertainty, and with only a couple weeks before the year concludes, there are still a number of unresolved issues hanging over the market.
However, despite these matters remaining outstanding, we end the year with some optimism as well. In fact, our base case for the stock market in 2023 guides for a considerable improvement, including a return to growth. The key issues this year
This time last year we were mulling the Federal Reserve’s plans to begin tapering its quantitative easing program. That included the prospect that it would accelerate the unwinding of its bond-buying activities.
Fast forward to today, and the Federal Reserve is still in focus. However, the theme at this month’s meeting will be whether the world’s largest central bank eases the pace at which it is hiking interest rates.
In many ways, this has been one of the defining issues of the year. Back in March the Federal Reserve launched its first rate hike in more than three years, and since then it has hiked interest rates a number of times.
This includes a series of ‘supersized’ 75 basis point hikes over recent months. The outcome of these hikes is that the cash rate has increased from 0% at the start of the year to at least 4.5% by the end of 2022.
These moves have been in response to elevated inflation, which remains well above where the central bank would like to see it. More recently, there are signs that the pace of inflation is starting to cool, albeit upside risk remains. Winners and losers
Looking back at the action from this year, the effects of elevated inflation and higher interest rates are immediately apparent.
Growth stocks have been largely out of favour in 2022, owing to uncertainties about valuations and the cost of debt. With rates rising, the risk-free rate of return has improved drastically, encouraging many investors to rotate into more defensive assets.
For companies with distant cash flows, or yet to reach profit, these stocks have been hit the hardest due to the number of uncertainties hanging over them.
This also ties in with one of the other pressing concerns over recent months - the economic outlook.
Thanks to soaring interest rates, and the small path that the Federal Reserve has to deliver a ‘soft’ landing for the economy, many observers are worried about a prolonged downturn. While we do not hold these concerns, it is something that the market has used to further justify a sell-off in growth stocks.
In this case, it has even flowed through to established, profitable, and high-growth tech stocks like Microsoft and Amazon, which traded at multi-year lows recently.
Our views here are shaped by our investment thesis. These companies offer lucrative growth opportunities throughout the economic cycle. That extends to periods where economic activity may subside.
Similarly, the effects of rising bond yields have also sought to undermine market sentiment throughout 2022. The yield curve has even recorded its steepest inversion in four decades, suggesting a recession is looming.
However, this metric may also go some way towards suggesting interest rates are peaking. And with the Federal Reserve recently indicating that it is prepared to step down the size of its rate hikes, it is our view that we are a lot closer to the peak of the rate cycle than where we started.
More broadly, this year may have been tricky for growth-oriented sectors, but there have also been areas for ‘opportunistic’ or prudent investors to achieve above-average returns. This year’s beneficiaries largely stem from resources, especially the energy sector, which features the likes of coal, oil, and gas.
Energy prices have been a topical issue throughout much of the world as utility bills soar. The war in Ukraine, now approaching ten months, has fuelled a shift in the global energy mix on account of sanctions, supply disruption, and the like.
During several moments this year, we also saw the impact of the war result in higher prices for other goods like food, chemicals, and agriculture products.
Even the notion that China may be in the midst of pivoting away from its COVID-zero approach has fuelled optimism for iron ore, copper, and other key resources.
With critical minerals policy also becoming a focal point, both home and abroad thanks to increasing demand for electric vehicles, it is clear that commodities have been the year’s focal area for outperformance. Our expectations in 2023
Although it may seem like things are stacked against the market heading into 2023, we believe there are a number of areas that could potentially reignite investor confidence. For starters, we see the Federal Reserve easing, and then pausing its rate hikes as inflation shows stronger signs of responding to monetary tightening.
We also believe that the economy is in a better position than many would have otherwise expected it to be while reaching the current benchmark rate level.
That means if the economy cools, as many expect, the downside could very well be limited, and the market may be shielded on account of more pessimistic expectations.
If anything, a downturn may prompt a rethink across investment sectors. In such an instance, we would not anticipate resources stocks to enjoy the tailwinds they have in 2022. Already, many commodities are well off their highs.
Instead, we see investors taking comfort once again in high-quality growth names. This does not mean indiscriminate enthusiasm for all tech stocks. It is more likely to be the case that support gravitates towards large-cap names that have a proven track record of leading, innovating, and growing.