Quarterly Investment Review – Q4 2022
In 2022 inflation returned with a force not seen for forty years. This was especially true in western economies where a confluence of forces, mostly Covid related, drove up prices. During 2020 and 2021 western governments provided huge monetary stimulus and organised generous relief packages to alleviate the Covid pandemic. The surge of spending in a world where many production facilities were running at low capacity, due to supply constraints caused by Covid, led to soaring price increases. This situation was exacerbated by the Russian invasion of Ukraine which led to tighter markets in oil, gas and wheat. Moreover, Covid changed the labour market, leading to labour shortages. A combination of health-related concerns and over generous welfare led in the US to the lowest worker participation rate for forty years. With nearly two jobs available for every unemployed worker wage pressure has been strong. This sharp and persistent inflation led to a belated reaction from the Federal Reserve to tighten liquidity, and both the bond market and stock market suffered sharp setbacks. In 2022 the US 10-year bond fell 14.7%, the German 10-year bond fell 18.6%, while the longer dated Austrian 2086 bond fell over 50%. In equity markets the S&P 500 index declined 19.4%, the MSCI Europe Index fell 14.9% in US dollars, and the MSCI World Index declined 17.5%. The US dollar was the strongest major currency rising by 6.2% against the euro and 12.5% against the yen. Very few asset classes managed a positive return for the year, and the largest falls were in the popular areas such as US technology stocks, the Nasdaq was down 33%. The outcome of this turmoil was an estimated $35 trillion wiped off financial wealth.
The strength of inflation caught policy makers by surprise. After a long period of keeping interest rates at close to zero, the Federal Reserve raised rates from 0.5% in April to 4.5% in December. While this is a level much lower than the rates that prevailed in the 1970’s and 1980’s the size of the debt now is far greater, so the impact is much more forceful. A 5% US interest rate today generates the same burden as a 15% rate in the 1980’s. It also marks a reversal in policy.
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