Today is the last day of 2022, a year that most in the investing community would treat with humility. After years of runaway gains and heady valuations in stocks, bonds, properties and digital coin prices, we’ve now been brought back to reality. As Warren Buffet famously said, “it’s when the tide goes out that you will know who has been swimming naked.”
Prices of all investment assets are ultimately based on future expectations. For a long time, the expectations have been built on the basis of a low interest rate regime, which meant that funding was cheap and the mechanical calculation of business valuation based on discount rates yielded high values. Now those expectations have changed because the interest rates have risen in 2022.
Back in 2020, Wall Street was Living in an Alternate World than Main Street
When Covid-19 struck in early 2020, there was an expectation that entire economies will be crushed. Stock prices plunged worldwide. Even oil briefly struck negative prices (the Western Texas Intermediate crude oil price was -$37/barrel at one point which is laughable because in 2022 we saw the oil price going above $100/barrel again). However, central banks then quickly slashed interest rates to help businesses and households with loans and printed money to resolve liquidity problems in financial markets and fund governments Covid-19 response programs. This immediately changed the expectations of the investors because central banks have again stepped into to save the financial world. Prices of assets all rose in tandem but the real economy still got crushed. Those who had invested in early 2020 reaped handsome gains through 2021 even when the economy was struggling through Covid lockdowns and supply chain disruptions. People started swimming in the sea without their trunks.
Towards the end of 2021, reality started to bite in the form of higher price inflation. Most of the world had relaxed Covid restrictions but China was still in lockdown mode and the supply chain was still constrained. Too much money printed in the western world was chasing after goods limited by the supply chain problems. US companies built up excess inventory and placed multiple future orders to try and mitigate the problem but this only made it worse because it sent false signals throughout the supply chain.
The Wall Street Party Stopped in January 2022
The US Fed was the first to take away the punch bowl when it started raising the US Fed fund rate in March 2022. Soon central banks around the world are forced to join in. By indirectly increasing the interest rates, the US Fed was trying to engineer a reduction in supply chain demand in the hope of tempering the inflation. It then spent the rest of 2022 increasing the rates ‘as high as and as long as it needs to’. No one knows how high and how long the rates will stay high. This uncertainly has invariably led to the expectations of a recession and economic decline. Prices of all investment assets have since crashed. Nothing was spared.
US Fed Funds Rate in 2022. Source: tradingeconomics.com
In reality, the economy is doing well. Stores are filled with shoppers and holiday locations are packed with travelers. Gas price is now close to a pre-pandemic $4/gallon in the US which is manageable for the wallets of most people. China is finally relaxing its Covid restrictions and this will heal the supply chain problems that have plagued the world for 3 years. Supply of goods will increase and this will temper price inflation.
Ironically, the expectations of the investment world is still stuck in the negative because of the uncertainties around the US Fed fund rate. Investors expect the US Fed to act against the interest of the financial world until they see the official inflation rate back down to 2%. This has led to a dismal investment return in 2022. US stocks, as measured by the S&P 500 is down 20%. The KLCI is down just 3%. Investment grade bonds are down around 13% globally. And they can continue to decline into 2023 until the US Fed stops raising the fund rate.
My Outlook for 2023
My opinion for 2023 is that the US Fed will over react in keeping its funds rate too high and/or for too long. They would rather be right in killing the high inflation than be wrong and having to do it all over again. However my view is that inflation is on its way down anyway with China opening up. If the US Fed succeeds in crushing the US consumer demand whilst global supply chain bottlenecks are finally removed, it will swing into the opposite territory of deflation.
Prices of investment assets may continue to remain depressed into 2023 until the US Fed stops its rate hikes. However, I think businesses and consumers will do better in 2023 as inflation stabilizes and consumer demand in China picks up. As I see it, there’s no noticeable slow down in US consumer demands. As the prices of stocks and bond remain low in 2023, I think 2023 will be a good year to accumulate stocks of robust global businesses and/or ‘dollar cost average’ into your favorite S&P 500 index ETF.
China’s opening up is also good news for Malaysian businesses. However Malaysia has to prove to foreign investors and businesses that it has able, stable and friendly policies. Foreign shareholding of Malaysian listed companies is at an all time low of 14% indicating the lack of confidence by foreign investment funds. Hence it is of no surprise that the 10-year return of the KLCI is currently negative. Malaysian stock prices will rise when foreign companies and funds have the confidence to invest in the country’s long term prospects.
Source: Bursa Malaysia