Nowhere to hide – The End of Free Money Takes Toll on Capital Markets in 2022
Life is unpredictable. Investment markets are no different. With few exceptions, the widespread rapid increase in interest rates across the globe, aimed at containing runaway inflation, weighed heavily on investment market returns in 2022. The unprecedented pace and magnitude of the rate hikes (especially those from the US Federal Reserve and Reserve Bank of New Zealand) pulled the rug out from under asset prices that had, arguably, been inflated themselves by historically low interest rates that had persisted for much of the last decade. The era of “free money” definitely looks like it has come to an end (for now at least).
Despite some mini-rallies during the year - where the slightest hint of good news (resilient corporate earnings, supply chains easing, economies re-opening, ‘looks like the Fed could pivot’?) was greeted with renewed, albeit often short-lived, optimism – the general trend for equity and bond markets in 2022 was downwards.
Diversifying away from these traditional asset classes (equities and bonds) paid dividends in 2022, albeit mostly in the sense of limiting losses within a multi-asset portfolio, rather than driving positive returns. Commodities, Hedge Funds, Direct Property and Cash were the only asset classes to deliver positive returns in 2022, a year that most investors will be keen to forget.
Before we do though, it is a good time to reflect on Mercer’s “Periodic Table” of investment returns. Produced annually, the Periodic Table colour-codes 16 major asset classes and ranks how each performed, on an annual basis, over the last 10 years.
Looking back at 2022 in the context of the last decade, the following can be noted from the Periodic Table:
- Four out of the 16 asset classes generated a positive return last year as rapidly rising interest rates weighed on returns from most asset classes. This was the lowest proportion of positive returns in any of the last 10 years. The next lowest number of positive returns was six in 2018 (the following year all asset classes generated positive returns – Hmmm?).
- This was a sharp contrast from 2021 where 14 out of 16 asset classes were positive (many in healthy double digits). Not surprising then that the returns for defensive Hedge Funds and Cash were the only ones to increase year on year in 2022.
- The leading asset class in 2022 was Commodities (+15.3%), influenced by the war in Ukraine and China’s strict zero-Covid policy, both of which constrained supply and fuelled inflation. Despite the strong returns in the last two years though, Commodities remains the weakest asset class over the 10-year period.
- In a year where few risks were rewarded, NZ Cash achieved its highest ranking in the Periodic Table, coming in fourth in 2022. 2018, the next most negative year, is the only other year where NZ Cash finished in the top half of the Periodic Table.
- Global equity investors were better off being unhedged over the year (albeit still suffering negative double-digit returns; -11.4% compared to a fully hedged NZ dollar return of -17.6%). The US dollar surged on the back of the Federal Reserve raising interest rates by 4.25% during 2022. The strong US dollar did little to help Emerging Market Equities (-13.5%), which were also negatively impacted by China’s strict ‘zero-Covid’ lockdowns.
- Bond markets offered little protection for investors, with New Zealand (-9.1%) and Global (-11.7%) Bonds both featuring in the bottom half of the Periodic Table for the second year running. The scale of the negative returns reflects the speed and scale of interest rate rises experienced during the year.
- In the battle of the Tasman, Australian Equities (-0.1%) beat New Zealand (-11.3%) for the second year running. Our Trans-Tasman neighbors benefitted from exposure to companies in the Resources and Financial sectors over the year. Australian equities still lag our domestic share market over longer periods, with our local bourse outperforming by 5.2% p.a. over the last 10 years.
- Global Listed Property (-24.0%) finished last on the Periodic Table this year and also took the prizes for the largest year-on-year fall (-53%) and the lowest annual return of any asset class across the whole decade. Investors in the sector have been on a wild ride in the last few years, having rebounded from last place in 2020 (granted the Covid-19 outbreak didn’t help) to second in 2021, before dropping back to last place this year.
- Highlighting just how negative 2022 was, of the 160 annual returns across the decade, 37 were negative and of these almost a third (12) were in 2022. This included six of the worst (i.e. most-negative) 10 annual returns in the Periodic Table.
- As a group, 2022’s asset class returns spanned a top-to-bottom range of 39%, above the period average of 34% and below the peak of 55% last year.
- Looking across the decade, equity markets have delivered a premium over more defensive assets, although as the Periodic Table highlights, much can change from one year to the next.
Periodic Table Takeaways
Regardless of risk profile (e.g. defensive, balanced, growth), diversified funds, including those offered via savings plans such as KiwiSaver, have exposure to a collection of the asset classes contained in the Periodic Table. In 2022, most, if not all, such funds experienced negative returns – there really were few places to hide. Those funds with more diversification than average should have delivered better results compared to those primarily invested in equities and bonds. However, such diversification hasn’t been well rewarded over much of the last decade.
The New Year is off to a fairly hot start - most asset classes had a very positive January - but as we look towards what the Periodic Table might look like come the end of 2023, it is arguably more difficult than usual (and usually it is impossible) to predict the outcomes from any investment markets in the year ahead. However, one thing that is almost certain is that cash returns will be higher than they have been for more than a decade. Whether investors will be rewarded for the risks they take in other markets, whether bonds, equities, real assets or alternatives, only time will tell. Those investors with time on their side can take comfort from the fact that such risks have generally paid dividends.