So far, 2022 has been a painful year for investors and the 2023 outlook is uncertain. The year began with optimism and gradually faded after the outbreak of the Russia-Ukraine war. On January 3rd, 2022, the S&P 500 index hit an all-time high of 4,797 and traded at a P/E of 21x and on October 12, 2022 the index reached a low of 3,577 trading at a P/E of 15x. The three major US indexes S&P 500, NASDAQ & RUSSELL confirmed a bear market on June 13, 2022 and the DOW confirmed a bear market until September 30, 2022, often a bear market precedes a recession.
Year-to-date, U.S. equity indexes are down 16% to 32%, while European equity indexes between 24% to 40% and Asian equities have decrease 23% to 31%. Global economic growth remains fragile, China is facing the lowest economic growth in more than four decades and recession risk has increased in Europe and Canada followed by the US. The stock market has priced a weak economic environment and share prices do not currently reflect the risk of a US recession that many expect.
We are in a new era of de-globalization. Supply disruptions caused by either the pandemic, national security or even sabotage have put the oil, gas and semiconductor industries in the spotlight. Geopolitical tensions are increasing as a result of Russia’s attack to Ukraine and China’s “peaceful reunification policy” and actions towards Hong Kong and Taiwan.
Russia is the top gas producer and second largest oil exporter in the world and is using its vast Siberian reserves to unleash the biggest energy crisis in decades pushing Europe into an outright recession. President Biden announced at the end of March 2022, that the Energy Department will release a historic record of 180 million barrels (about 1 million barrels of oil per day) from the strategic petroleum reserve to lower prices and address the mismatch of supply and demand that exist in the market.
Asia is currently responsible for 75-80% of global chip manufacturing, mainly in Taiwan, South Korea, Mainland China and Japan. As a result, the Biden administration announced at the end of August 2022, the CHIPS Act to transform and advance the US leadership in the research, development and manufacturing of semiconductors. The US Department of Commerce introduced on October 2022, sweeping rules aimed at restricting China from obtaining high-end chips used in artificial intelligence, supercomputing and other technologies. However, China has pledge to speed up innovation in areas vital to technology self-reliance.
WTI is trading at USD $85 per barrel and natural gas at USD $5.5 per million of BTU. The surge in oil and gas prices over the past two years has produced an energy crisis in Europe similar to the financial crisis. Historically, gold has been a safe haven similar to Treasuries, but its price has decreased 21% from its record high of USD$ 2,131 on August 6, 2020. Bitcoin also showed some sign of “safe haven” during the Covid pandemic as technology stocks soared, yet year-to-date has lost roughly 60% of its value and 70% from its record high of USD $67,000 on November 8, 2021 leading a rout in crypto that has caused pain throughout the industry. Ethereum has shown a more pronounced decline of 73% from an all-time high of $4,735 on November 9, 2021. The pullback in cryptocurrencies triggered a series of bankruptcies, layoffs, failures and highlights that, for now, digital assets are not viewed as the safe heaven asset to store value or hedge against inflation. In times of uncertainty and stress, the US dollar is proving to be the world’s safe haven asset and king. Since we do not expect the FED to embark on easing soon, a US dollar peak may be several quarters away. From stocks to bonds, credit to crypto, investor sentiment is at the low end of its historical range and for now are sitting on an estimated USD $5 trillion in cash.
In 2022, the US annual inflation rate in June reached 9.1%, the biggest yearly increase since 1981. Rapid rate hikes by G10 central banks and rising real yields are rippling through the economy as investors, corporations and entrepreneurs adjusts to the higher cost of doing business via higher interest rates, labor and cost of capital. Higher cost of capital has reduced the valuation of all companies, public and private. Tightening financial conditions is creating stress in debt markets by increasing credit spreads, rising default risks, shrinking bond-market liquidity and inducing currency turmoil particularly in emerging markets. Soaring mortgage rates have led to the worst housing affordability since 1985 with the average mortgage rate for a 30-year fixed loan continue to march towards 7.0% reaching the highest levels since 2007. Housing affordability in the US both for owners and renters is at the worst levels since 1985. Shelter makes up about a third of the overall basket of consumer prices. Inflation diminish the purchasing power of households and erodes real incomes, particularly those at the bottom of income distribution.
"...as proven by history, for every bear market, a bull market follows. The start of the bull market almost always begins during recessions when the economy is weak and bad news abound.”
The late NYU economist Solomon Fabricant coined the term “growth recession” in research published in 1972 where the efforts of reducing inflation is likely to require a sustained period of below-trend growth and softening of labor market conditions while trying to avoid an economic contraction. FED Chair Jerome Powell in a speech at Jackson Hole on August 26, 2022 said policy makers were committed to bringing inflation back to its 2% target, but the effort would likely require a “sustained period of below-trend growth” that would mean “some pain to households and businesses.” Monetary policy does not resolve bottlenecks in global supply chains and disruptions. However, it can slow overall demand to address demand-related inflationary pressures. The good news is that there are encouraging signs inflation is abating via lower oil prices, stronger dollar and some improvements in supply-chain disruptions.
Capital markets are cyclical in nature. Since the 1800s, the S&P 500 has experienced 29 bear markets and on average bear markets in the US last 26 months. Fortunately, as proven by history, for every bear market, a bull market follows. The start of the bull market almost always begins during recessions when the economy is weak and bad news abound. On average recession in the US last 13 months from peak to through. A peak in the FED policy cycle is an important catalyst and part of the recovery puzzle. The S&P 500 is expected to finish between 3,600 to 3,800 points in 2022 and about 4,200 and 4,500 points in 2023. In the current environment, the forward paths of inflation, economic growth, interest rates, earnings, valuations and geopolitical outcomes are difficult to predict. However, the payoff for identifying MegaTrends and being invested when anticipating a recovery has been very rewarding for long-term investors.
Pedro David Martínez
CEO, Regius Magazine.
Head of Research, Regius Magazine.