2022: It’s been a year to remember and, more accurately, a year to forget
2022 was unlike any other year, with twists and turns worthy of a Netflix drama. After a bull market that lasted for more than a decade since the Global Financial Crisis of 2008-09, global markets experienced a massive pullback. Whether you were a conservative investor with a concentration of high-quality bonds, or an aggressive investor with a concentration of the most go-go of tech stocks, you are nursing losses. In fact, 2022 was just one of five in the last 100 years where both U.S. Treasuries and the S&P 500 finished in the red. To say we are excited to see the back of 2022 is an absolute understatement.
What largely drove the bull market between 2009 and 2021 were a few separate, but related themes: explosion of revenue growth in high flying sectors like information technology and communications services, low inflation, and a very prolonged period of low interest rates, coming out of the global financial crisis. Persistently low interest rates not only resulted in a low cost of capital for companies in growth mode, but also caused investors to give very high multiples to companies who delivered high sales growth rates. In most cases, these companies were and still are far from profitability.
During the early days of the COVID-19 pandemic, countries all around the world disbursed huge sums of money in order to keep businesses afloat and cushion the pandemic’s economic impact on their citizens. Injecting huge amounts of cash into the economy has always come with consequences, and everyone knew that the only question is when will the time of reckoning be. Turns out, the answer was 2022.
From an investment style standpoint, value massively outperformed growth across the globe. This was the theme throughout the year with that trend being supported by underwhelming earnings weighing on tech stocks in the final three months of the year, while concerns about slowing global economic growth combined with rising bond yields hit richly valued tech stocks throughout 2022. Value stocks, meanwhile, were viewed as more attractive in the market environment of 2022 due to lower valuations and exposure to business sectors that are considered more resilient during turbulent times than high-growth parts of the market.
Energy was, by far, the best-performing sector in the market as an early-year surge in oil and natural gas prices in response to increased geopolitical risks and reduced Russian supply helped push energy stocks sharply higher. Defensive sectors, specifically healthcare and consumer staples, were the next best-performing sectors for the year finishing the year with small gains and losses, respectively, again as investors rotated towards less economically sensitive corners of the market amid rising recession risks.
Amidst an expectation of continued global economic slowdown (if not an outright recession), many investors sought safety in assets like bonds and commodities, though rising interest rates have made the value of bonds issued previously fall. This has made buying in bonds and other fixed-income assets a tricky affair and yielded mixed results for investors. Although commodities like precious metals have been a historical hedge against inflation, their performances in 2022 have also suffered, owing to the expectation that slowdowns in the global economy will lead to weaker demand for raw materials in the foreseeable future.
US Markets
Jan. 3, the first day of market trading in 2022, looked like just another day in a stock rally that began during the infancy of Barack Obama’s presidency. The S&P 500 hit a record high. Tesla, the company that upturned the auto industry and made many investors rich, rose 13.5 percent and came close to its own all-time peak. That Monday, as it turned out, was actually the end of a market that for over a decade had gone mostly in one direction in which the S&P 500 rose more than 600 percent since March 2009. Just two days later, the US Federal Reserve released the minutes from its previous meeting — a typically routine event on Wall Street — revealing that policymakers at the central bank were so worried about inflation that they thought they might need to accelerate how fast they raised interest rates. Investors took it badly, causing the S&P 500 to tumble 1.9 percent and igniting a stock sell-off that set the stage for the rest of the year.
The past 12 months have marked a generational shift for US markets as the Fed, racing to contain the worst inflation in decades, repeatedly raised interest rates. Its efforts have begun to pay off – Price increases started showing early signs of slowing towards the end of the year. Neither the S&P 500 nor the Nasdaq 100 or the Dow Jones has since reached the heights they achieved during the first trading session of the year. The S&P 500 declined 19.4 percent for the year — its worst annual performance since 2008.
The Fed’s challenge became even harder in late February when Russia’s invasion of Ukraine sent food and energy costs soaring, creating a crisis in countries around the world dependent on the import of oil and grain. Higher interest rates are central banks’ primary tool for combating inflation and as the Fed raised interest rates by 425 basis points – the steepest rise in a calendar year in its history, borrowing costs rose. Subsequently, the yield on 10-year U.S. government bonds, which underpin borrowing costs across the globe, has soared 2.36 percentage points this year, its biggest annual rise on record for data going back to 1962. In turn, borrowing rates on mortgages, company bonds and other debt ratcheted higher. This is projected to eventually lead to slowing demand in the economy and in theory tempering further price increases.
As stock markets are forward looking, all of these aforementioned factors sent stocks lower as higher costs and slowing demand translate to lower profits for companies in the near future. That proved especially true for tech companies, whose growth had been supported by low interest rates. The Nasdaq Composite index, which is chock-full of tech stocks, has fallen 33.1 percent in 2022 with some companies making up the index such as Tesla dropping by 65% during the course of the year.
But even as the U.S. economy heads toward a possible recession, the Federal Reserve has said its job is far from over. Inflation, while starting to cool, is still far too high, and interest rates are predicted to rise further to above 5% and be at that level for the foreseeable future, foretelling more pain despite these projected hikes estimated to be at a slower pace. “Central banks drove markets this year because of inflation, and that will continue into 2023,” said Kristina Hooper, chief global market strategist at Invesco. “This is a very, very dramatic, history-making moment in time. We have all been witness to a sequence of events, starting with the pandemic, that has been extraordinary.”
The relative strength of the United States and its resilient economy despite rising inflation made it a safe place for investors to put their money, and this influx of cash helped push the value of the dollar higher. In September, this unprecedented move for the US Dollar throughout the year resulted in the dollar briefly trading at its highest level in over 20 years against the euro, its highest level in 24 years against the Japanese Yen and the strongest level ever against the British Pound.
A year ago, bank analysts responsible for projecting where stocks and bonds would end in 2022 were somewhat optimistic. According to a Bloomberg aggregation of forecasts, even the most pessimistic prediction for the S&P 500 at that time — made by Morgan Stanley — thought the index would finish the year 10 percent higher than where it eventually closed. Now, the most optimistic strategist this year, Scotiabank, doesn’t expect the S&P 500 to even make up that lost ground in 2023, while most expect the market to end roughly where it’s starting, after a dip early in the year.
Eurozone
Beyond the US, 2022 was a historically bad year for European markets exemplified by the performance of its sovereign debt markets, which were hammered by interest rate rises by the European Central Bank and the US Federal Reserve resulting in its first bond bear run in more than 70 years whereby the yield on German 10-year bonds suffered its biggest selloff going back to the 1950s, according to Bloomberg data.
2022 will also be remembered as the year of the mini-budget crisis. Kwasi Kwarteng’s plans for unfunded tax cuts sent sterling cratering to a record low of about $1.03, and caused a dangerous selloff in government bonds. The yield on 30-year UK government debt surged from 3.5% to more than 5% after the mini-budget, as investors questioned whether Liz Truss’s administration could run a sustainable tax and spending policy. This created a fire sale, in which some pension funds were forced to offload billions of pounds of UK government bonds, or gilts, at distressed prices. Some funds came close to collapse before the Bank of England stepped in with a pledge to buy bonds. That intervention calmed the markets, but gilt yields have been creeping higher, with 30-year bonds now yielding more than 3.9%.
By the end of September, 2022 had been the most devastating year for European bonds since at least 1926, according to one estimate as investors with classic “60/40” portfolios (60% in shares and 40% in bonds) were facing the worst returns for a century, BofA Global Research warned in early October.
As inflation continued surging, Russia triggered an energy crisis in Europe by weaponizing gas supplies resulting in gas prices jumping to a peak of €321 a megawatt-hour (compared with €27 a year earlier), after Gazprom announced the closure of its Nord Stream 1 pipeline to Germany for maintenance. Despite the disruption, Europe managed to fill its gas storage facilities, helped by an influx of liquid natural gas (LNG). However, by end of the year, benchmark European gas prices fell back to levels last seen before the Ukraine invasion.
Asian Markets
After rising for most of October and November, the Japanese stock market declined in December. Nevertheless, the total return for the fourth quarter remained positive, at 3.3% in yen terms. Having weakened against the US dollar for most of 2022, the yen reversed direction from November, returning to levels last seen in July and August.
The main event for investors in Q4 was the decision by the Bank of Japan to widen the band within which it has been maintaining 10-year bond yields. Although the change in yield-control policy is not a de-facto interest rate rise, it came as a complete surprise and this was sufficient to drive a sharp strengthening of the yen in December. The earlier than expected move by the central bank may also reflect a belief that Japan’s inflation rate is finally moving into a more sustainably positive range after decades of deflation. The Japanese government was able to assemble an additional substantial fiscal package in the fourth quarter, through which it aims to bolster the nascent domestic recovery in 2023.
While Asia, along with the rest of the world, faced multiple stagflationary shocks in 2022, they weathered these shocks better. Indeed, we believe Asia will enter a rapid phase of disinflation and is well-positioned for growth outperformance in 2023. The step up in Asia’s inflation was smaller compared to other regions. Furthermore, Asia’s inflation had more of a cost-push element, meaning it was driven to a large extent by increases in cost of raw materials. And we believe Asia’s inflation already peaked in third quarter of 2022.
Asia’s inflation should be rapidly returning towards central bank’s comfort zone. We expect this to be the case for most Asian economies by mid-2023. Cost-push factors are fading, resulting in lower food and energy inflation. Core good prices are descending rapidly, given the deflation in goods demand. Moreover, labour markets were not that tight in Asia, and wage growth has remained below its pre-COVID rates. Because of this backdrop, we’ve argued that central banks in Asia do not need to take policy rates deeper into restrictive territory.
While weak external demand will remain a drag at least through the first half of 2023, Asia’s domestic demand is supported by three factors. First, the easing of financial conditions will lift the private sector sentiment. Second, we are witnessing a strong uplift in large economies like India and Indonesia, supported by healthy balance sheets. Finally, China’s loosening of pandemic restrictions that have constrained its economic growth since 2020 will lift consumption growth and have a positive effect on economies in the region, principally via the trade channel, helping Asian economies to get onto the path of growth outperformance.
There are, of course, risks to our optimistic outlook for Asia. If U.S. inflation stays elevated for longer, this would lead to more tightening by the Fed than is expected and could drive renewed strength in the USD. This in turn would prolong the rate hike cycle in Asia, keeping financial conditions tight and exert downward pressures on growth. A continued worsening of the Covid-19 spread in China along with new variants could impact its growth trajectory with adverse spill over implications for the rest of the region.
Commodities
Commodities, particularly food and energy, were unusually volatile throughout the year in response to geopolitically driven supply concerns following Russia’s invasion of Ukraine back in late February. After being up as much as 41.8% at its peak in March, the Bloomberg Commodity Index (BCOM) finished the year with a gain of 13.8%. This followed a 27% rise in 2021, which then marked a 42-year high. WTI crude also peaked in March at the $130.50 price level (+73.5%) before finishing at $80.26 (+6.7%).
Precious metals surged in the final quarter of the year primarily due to the decline in the U.S. dollar, leaving spot gold with a modest decline of 0.3% and spot silver with a modest gain of 2.8% for the year. While those returns performed relatively well versus both stocks and bonds, precious metals have been serious laggards over the prior decade. The S&P 500 outperformed gold in eight of the prior ten years ending 2021 with a total return of 362% versus +16.9% for gold.
Gold’s glaring underperformance over the last decade has seemingly reduced its place in investor portfolios in favour of vastly outperforming growth stocks, and continuously rising treasury bonds. However, the trend of gold underperformance may be ready to change with growth stocks being amongst the hardest hit equities in 2022, and their underperformance would be expected to continue if the Fed follows through on its forecast to keep rates elevated throughout all of 2023 while typical safe-haven treasuries just cemented their steepest decline in modern times.
In the fourth quarter, energy stocks were helped by progress on the post-Covid economic reopening in China which increased energy demand expectations, while a falling dollar was an added tailwind for commodities including oil and gas. More to that point, the other strong sector performers in the fourth quarter were industrials and materials, which also benefitted from an improving Chinese demand outlook and a weaker U.S. dollar.
Nairobi Stock Exchange
The local equities market eased 0.7% in the fourth quarter of 2022, partially reversing gains made in the third quarter (+3.2%). In the year, all the benchmark indices posted a double-digit drop. The NASI slumped 23.4%, with the largest decline seen in the second quarter of the year. The NSE 20 and NSE 25 fell 11.9% and 16.3% respectively. Compared to other key African markets, the NSE posted negative USD returns of 30% in the year, battered by the strengthening USD. Out of the 17 African stock markets that we reviewed, only 5 posted positive USD returns.
Turnover for the quarter stood at USD 136m, lower 27%q/q. In the year, the value of shares traded was USD 753.3m, making it the lowest annual turnover since the year 2012. The subdued trading activity was a result of several factors, both global and local. With the rising inflation and interest rates, investors preferred short-tenor bonds to equities. In addition, the strengthening USD had foreign investors rethinking investments in frontier markets. Foreign investors were net sellers for the third consecutive year, recording net outflows of USD 197.9m.
Four stocks accounted for 85.3% of trading activity, led by Safaricom; the others were Equity Group, KCB and EABL. Of the top ten movers, six ended the year higher. The leading gainers of the year were Car & General (adjusted for the bonus issue) and NCBA Bank, up 179.5% and 56.2% respectively. On the other hand, Centum and NBV were the leading laggards of the year, down 40.7% and 37.8% respectively.
Outlook: The market conditions and investor sentiments of 2022 are expected to extend to the first half of 2023, with monetary policies still geared towards taming inflation and forex risk management. As the policies take effect, we expect some correction in the second half which could trigger higher investor activity in our market. However, Kenya’s weak fiscal position may delay the recovery.
In the Fixed Income market, the secondary bond market turnover declined by 19.8% to KES 736.9 bn in 2022, from KES 919.1 bn recorded in 2021, partly attributable to the relatively tightened liquidity and increased allocation to short-term government papers. Primary T-bond auctions recorded an undersubscription, with the subscription rate averaging 94.3%, lower than the 150.8% average subscription rate recorded in 2021, as investors’ preference for shorter tenor papers persisted.
T-bill auctions were also undersubscribed in 2022 with the average subscription rate coming in at 96.4% slightly higher than the average of 91.9% recorded in 2021. The average subscription for the 91-day instrument however came in at 234.6% following the sustained demand for the shorter tenor paper as investors sought to avoid duration and interest rate risks.
In 2022, the yield curve exhibited upward pressure due to the elevated inflationary pressures which saw investors demand more compensation for the risks borne. The yields on the 364-day, 182-day and 91-day papers increased by 1.3% points, 1.4% points and 1.2% points to an average of 9.9%, 9.0% and 8.2%, from 8.6%, 7.6% and 7.0%, respectively.
In 2023, the general economy is expected to exhibit slower growth compared to 2021 and 2022 as the adverse effects of the COVID-19 pandemic dissipate. We expect interest rates in the fixed income market to remain high given the funding requirements by the government as the new regime takes shape. As such, we expect investors to remain biased towards short-term fixed-income securities in a bid to reduce duration risk as well as interest rate risks. Despite this, we expect investors to take advantage of the high returns on the medium to longer term papers. Key to note, domestic borrowing could be slowed by the concessional multilateral loans from institutions such as the IMF which would consequently reduce the government’s cash crunch.
Looking forward to 2023
Markets ended 2022 on a decidedly negative note and the December losses helped to ensure that 2022 was the worst year for stocks since 2008 and the worst year for bonds in multiple decades, as both asset classes posted annual declines for the first time since the 1960s.
Many of the risk factors – decades high inflation, a historic Fed rate hike campaign and geopolitical unrest that contributed to a lacklustre 2022 investment landscape still loom on the horizon as we enter 2023. Hence, many market participants are more cautious than optimistic. Furthermore, it is worth remembering that these factors are only the ones we know about. If recent years have taught us anything, it is that black swan events might be more common than previously thought, and we need to always account for ‘unknown unknowns’, be they natural disasters, social upheaval, business decisions, or geopolitical events. But while the risk factors discussed earlier were clear negatives for asset prices in 2022, it’s important to note that as we enter 2023, the market is approaching a potentially important transition period that could see each of these headwinds ease in the months ahead.
First, inflation has shown definitive signs of peaking and declining. The US Consumer Price Index has fallen from a high of 9.1% in June to 7.1% in November, while other metrics of inflation have registered similar declines. Now, to be clear, inflation remains much too high in an absolute sense, but if price pressures ease faster than expected, that will present a positive surprise for markets in the first several months of 2023.
Second, after a historically aggressive rate hiking campaign in 2022, the current Fed hiking cycle is likely nearly complete. In December, the Federal Reserve signalled that it expected the peak interest rate to be just 75 basis points higher than the current rate. That level could easily be reached within the first few months of 2023 and the Fed ending its rate hike campaign will remove a significant headwind from asset prices.
Finally, while both economic growth and corporate earnings are expected to decline in 2023, those negative expectations have been at least partially priced into stocks and bonds at current levels. As such, if the economy or corporate America proves to be more resilient than forecasts, it could provide a positive spark for asset markets in early 2023.
As we start the new year, we should fully expect financial media commentary to be focused on the 2022 losses and current market risks, including earnings concerns and recession fears. But the market is a forward-looking instrument, and while there are undoubtedly economic and corporate challenges ahead in 2023, some of those best-known risks are partially priced into markets already, and the truth is that there are potential positive catalysts lurking as we start a new year.
More broadly, market history is clear: Declines of the magnitude we saw in 2022 are usually followed by strong recoveries, not further weakness. The S&P 500 hasn’t registered two consecutive negative years since 2002, while bonds, represented by the Bloomberg U.S. Aggregate Bond Index, have never experienced two negative consecutive years. And that reality underscores an important point, that market declines such as we witnessed in 2022 have ultimately yielded substantial long-term opportunities in both stocks and bonds.
The stagflation of the 1970s and sky-high interest rates of the early 1980s eventually gave way to the strong economic growth and market rally of the 1980s. The dot-com bubble burst of the early 2000s was followed by substantial market gains into the mid-2000s. The financial crisis, which remains the direst economic situation we’ve experienced in modern market history, was followed by strong rallies in the years that followed, and not even the worst global pandemic in over 100 years could result in sustainably lower asset prices.
As such, while we are prepared for continued volatility and are focused on managing both risks and return potential, we understand that a well-planned, long-term-focused, and diversified financial plan can withstand virtually any market surprise and related bout of volatility, including multi-decade highs in inflation, historic Fed rate hikes, geopolitical unrest, and rising recession risks.
As always, we will remain patient and stick to the long-term plan, as we’ve worked to establish a diversely unique, asset allocation mix based on risk tolerance, and investment timeline. We remain vigilant towards risks to portfolios and the global economy, and we thank our investors for the ongoing confidence and trust.