With our final newsletter of the year, we wanted to recap the major events that moved markets and highlight some investor takeaways.
Upon reflection, 2022 was a year of inflection. Australia emerged from two years of intermittent COVID-19 lockdowns. After a decade of low-interest rates and inflation, both increased sharply. Mortgage rates subsequently tripled. A decade of growth companies outperforming ended, typified by the FAANG index falling 40%. Commodities were back in vogue, while cryptocurrency kept finding new and innovative ways to trip over itself. Here is our 2022 Year in Review.
End of the P/S ratio
A decade of increasingly cheap money reached a climax in 2021, with rates pegged to zero and markets flush with liquidity. Investors chased assets that showed high growth, particularly tech companies, and were willing to accept profits many years into the future, if at all. The traditional price-to-earnings (P/E) ratio was cast aside for the more flashy price-to-sale ratio (P/S).
In 2022, this trend quickly reversed. With the realisation that inflation would be stubborn and central banks would need to hike interest rates rapidly, investors quickly rotated into profitable companies. The technology-heavy NASDAQ 100 retreated 29%. Companies that continued to double down on growth were punished, most notably Meta (META.NASDAQ), formerly Facebook. Closer to home, buy-now-pay-later simply became buy-never, as investors fled from business models yet to produce sustainable earnings. Once a market darling, Zip Co (ZIP.ASX) finished the year down 87%.
Russia invades Ukraine
Even in the weeks leading up to Russia’s invasion of Ukraine, it seemed a low possibility Vladimir Putin would try and take Ukraine by force. Then on 24 February, he attempted to do precisely that. Given little chance by most, Ukraine stood its ground. Now the two nations are locked in an unresolved stalemate, with 200,000 estimated to be injured or killed.
Unintentionally, Russia galvanised NATO and unified the West into a coordinated and unprecedented level of sanctions, including asset freezes, cutting off payment networks and export bans. The bans on coal, gas and oil have highlighted the lack of energy security, particularly among European nations. Russia accounted for nearly 30% of petroleum imports and 39% of natural gas to the European Union.
Ukraine’s importance in the global food chain also came to light, given it provides a third of global wheat production, 19% of corn and 80% of sunflower oil. As we predicted, this caused upward pressure on the price of commodities. It also exacerbated the fight against inflation, leading to a more hawkish central bank rhetoric and further rate hikes.
After an election largely based on the nation’s dislike for former Prime Minister Scott Morrison, rather than any notable policy differences, Labor and Prime Minister Anthony Albanese were elected into government. Nine years on the sidelines meant there was no time to waste, with legislation passed on a 43% emissions reduction by 2030, aged care reform and an integrity commission passed. Albanese even managed to get union and the business communities in one room to thrash out how to get wages moving at the Jobs & Skills summit. However, this is where the romance began to fade.
The government passed its fair work legislation, which looked reasonable at face value. It prohibited pay secrecy, limited the use of fixed contracts and increased gender equity and safety in the workplace. However, business was blindsided by what is termed multi-employer bargaining. In simple terms, if a company with more than 50 employees doesn’t have an enterprise agreement, it could be roped into a broader agreement with companies of similar activities. The idea is to increase the bargaining position of employees. But how it will work in practice is less obvious. Currently, it looks like the only beneficiaries will be lawyers.
Then in an effort to curb soaring energy bills, the government introduced temporary caps on coal and gas prices for twelve months. More concerning is the mandatory code of conduct to sell gas at a “reasonable price”. Effectively this would let the government dictate what prices and subsequently returns producers would receive on an indefinite basis. It’s unclear in practice how this will be carried out and the longer-term impacts on energy investment in Australia.
For a government with few policy differences, it’s looking noticeably anti-business and light on the finer details.
Inflation and Interest Rates
Inflation was the dominant driver of markets in 2022, led by both tremendous demand from consumers and pandemic-induced supply constraints. Record-low unemployment, government stimulus and closed borders created the perfect demand storm. Households and businesses held historic cash buffers and were keen to spend once COVID-19 restrictions eased in the early months of this year. Supply constraints were most noticeable in shipping and labour, and were only exacerbated when Russia invaded Ukraine.
Subsequently, central bankers worldwide scrambled to hike interest rates to avoid inflation entrenching itself. It’s hard to believe in November last year, Governor Philip Lowe said the conditions for a rate rise wouldn’t occur until 2024. Since April, the cash rate has been increased for eight consecutive months to 3.10% as the RBA chased the inflation rate higher.
As we wrote in August, the inflation battle is largely already won. The Bloomberg Commodity Index has fallen 20% from its highs, while shipping rates have plunged 70%. Inflation measures the rate of change over a given 12-month period, meaning the prices will need to increase again from already elevated levels.
Yet central banks are still hiking rates, for which the impacts are less well understood. Monetary policy acts with a lag, so it will take 12-18 months for its impact to trickle through the economy. Markets have already moved to price in the impact, with growth companies derated and real-estate investment trusts (REITs) trading at discounts to net asset values. In Australia, house prices have fallen 7% as mortgage repayments increase and the borrowing capacity of new buyers diminishes. Inflation was the key driver of markets in 2022. It wouldn’t be surprising if interest rates and subsequent repercussions are the drivers of 2023.
Markets & Commentary
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