Could 2022 get better from here, it’s certainly hard to get worse
By Stephen Bennie
First off, here’s some good news, history shows that the share market always recovers from drawdowns and in due course goes on to make new all-time highs. However, there is no hiding from the fact that so far 2022 has been a torrid time for investors in the majority of asset classes. Bonds and shares have both suffered sharp sell offs. June has seen most developed countries share markets drop into bear market territory, down 20% or more. It’s been countless decades since share markets had such a bad start to a year. And several centuries since the bond market had a worse start to the year, 1700s to be exact.
Chart showing the worst start to a year in the S&P500 since the 1930s
Chart showing the worst start to a year for US 10-year Treasuries since 1788
Times like these can be particularly challenging for investors in our part of the world. As investor sentiment deteriorates and correlations between share prices and markets across the world tighten, business fundamentals are temporarily irrelevant. What matters most is what the S&P500 does overnight, that determines how our market performs on the day. At least an American investor can wake up and hope the day is going to be better for their share portfolio. In New Zealand we wake up to see the S&P500 down and before we’re even out of bed, we know its going to be a bad day for our share portfolio. It can become a depressing spiral. Especially a really weak Friday in the US share markets, we get to spend the whole weekend knowing we’re going to have a bad Monday to start the week. Worse still is waking up in the night and having a peek on your phone at a business website to see how the US is trading, that can lead to sleepless nights if your peek reveals a sea of red.
The cause of this current chaos is the trifecta of doom that has unfolded in the past 6 months. Governments and central banks around the world had over stimulated the global economy in their response to the pandemic which created inflation. Demand has been more than supply has been able to cope with thus creating inflation that was not “transitory”, which meant central banks with their zero interest rate settings were miles behind the curve. That was the first leg of the trifecta. Second leg was the invasion of Ukraine which triggered energy and food prices to rise sharply which further fuelled inflationary pressures. And to complete the trifecta China’s decision to lock down whole cities for months to eliminate the virus further exacerbated supply chain issues, further fuelling inflation.
Chart showing the jump in US CPI
The chart above really visualises the problem created by the trifecta of doom. It shows monthly US inflation readings, they annualise each month. You can see the deflationary pressures that the government and central bank were dealing with in 2020, energy prices fell due to the lock downs and travel restrictions. Then moving forward, you can see the steady march higher through 2021 and now into 2022. The latest reading this month showed annual inflation running at 8.6% with forecasts suggesting a top out at 9% in the next couple of months. And then after that and into 2023, inflation is finally forecast to start moderating back down.
That moderation is forecast to be quite rapid, due largely to the sharp spikes of the first half of this year become harder to replicate going forward. The silver lining of the situation is that because inflation jumped quickly it can fall back quickly. Especially if central banks can get their monetary policy setting halfway right, to help get demand and supply closer to some sort of equilibrium. And they have been trying to do exactly that in recent months. When the European Central Bank moves early next month that will have over 60 central banks around the world raising rates in 2022. The concerted and widespread nature of these moves indicates a global determination to get inflation under control. The other aspect of the moves that also shows that determination is how quickly central banks are raising rates. This month the US Federal Reserve increased by 0.75%, the first such move in 28 years, which took its funds rate up to 1.75%. If, as is now expected, they move another 0.75% at their next meeting their funds rate will have reached 2.5%. The path ahead is starting to look very much like come the first quarter next year interest rates will have risen to 3-4%, varying by country, and inflation will have dropped to 3-4%, again varying by country.
If it does turn out that by early next year central banks have inflation under control, then the damage caused the trifecta of doom should abate. Also, worth noting that markets tend to look ahead by 6 to 9 months which means that if it does appear that this is the path forward, we could see volatility easing as we move into the second half of 2022. Then it will become about how the global economy bears up under the likely cooling off in demand. But that is a matter for 2023, right now most investors would settle for the second half of 2022 to be a little kinder.
Disclaimer
The following commentaries represent only the opinions of the authors. Any views expressed are provided for information purposes only and should not be construed in any way as an offer, an endorsement or inducement to invest. All material presented is believed to be reliable but we cannot attest to its accuracy. Opinions expressed in these reports may change without prior notice. Castle Point may or may not have investments in any of the securities mentioned.
About Castle Point Funds Management Limited
Castle Point is a New Zealand boutique fund manager, established in 2013 by Richard Stubbs, Stephen Bennie, Jamie Young and Gordon Sims. Castle Point’s investment philosophy is focused on long-term opportunities and investor alignment. Castle Point is Morningstar Fund Manager of the Year 2021 – Domestic Equities.
About Stephen Bennie
Stephen is a co-founder of Castle Point. He has over 25 years of investments experience and 18 years of portfolio management experience in New Zealand and abroad. Stephen holds a Bachelor of Commerce (Hons) in Business Studies and Accounting from the University of Edinburgh in 1991 and is a CFA charterholder.
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