2022 was a pretty rought year. Because of a slowdown in consumer spending and recovering supply chains, we expected the elevated inflation to spike late in the Spring and then gradually normalize but nonetheless remain above the historical average by the end of the year. However the invasion of Russia into Ukraine in February considerably altered the macroeconomic landscape.

 

Particularly oil, natural gas and food prices soared, adding more upward pressure on inflation, which in January already stood at 7,5% in the United States and 5,1% in the Eurozone. Being heavily reliant on Russian natural gas, wheat, and other commodities, the impact would be more considerable in Europe where governments intervened by setting price caps on gasoline. Oil went as high as 130,50 dollars per barrel in early March after which the International Energy Agency (IEA) and others agreed to release oil from strategic reserves to help ease the prices.

 

Under these circumstances clearly inflation was not going to ease this early in the year and central banks worldwide would need to act more aggressively to prevent it from spinning out of control. The Federal Reserve raised the interest rate first in March by 0,25% then by 0,50% in May, then by 0,75% in June, followed by three more 0,75% increases, and finally another 0,50% increase last month to bring it to 4,50% at year end. This series of interest rate increases is unprecedented. The European Central Bank followed suit and increased their interest rate first in July by 0,50% then by 0,75% in September and again in October and lastly by 0,50% in December to bring the interest rate from zero to 2,50%. Also the Bank of England, Switzerland, Australia, Canada, and others raised their interest rates to curb back inflation.

 

Inflation eventually spiked at 9,1% in June in the United States, the highest level since 1981, and has since been on the decline to drop to 6,5% at the end of the year. In the Eurozone inflation peaked in October at a stunning 10,7%, the highest since at least 1991, and closed the year at 9,2%. Also in the UK inflation spiked in October to 11,1% and closed the year still in double digits at 10,1%. In part as a result of the more aggressive actions by the FED compared to the ECB, the dollar gained 5,86% against the Euro in 2022, closing the year at 1,0702 USD/EUR. From September to November the dollar even exceeded the Euro in value, which hasn't occured since 2002, with the Euro going as low as 0,9535 USD/EUR.

 

As a result of the decades-high global inflation and unprecedented interest rate increases, the concern for a recession evidently followed. In fact in the USA first and second quarter GDP growth were negative, but a recession was not declared because the unemployment rate was and still is near the lowest since 1970. A strong third quarter and expected strong fourth quarter will likely result in positive United States GDP growth for 2022, but it will not be nearly as strong as in 2021 when the COVID19 restrictions were lifted and people went with their savings on a massive shopping spree after a full year of lockdowns which, combined with disrupted supply chains and historically low interest rates, were the prime reason inflation got to spin out of control in the first place. Also in the Eurozone GDP growth is expected to remain positive around 2% for 2022, but below the 3,9% of 2021.

 

The chance for a recession however is still real, even likely, and it already weighed on the global markets throughout 2022. The Dow Jones, S&P500 and Nasdaq dropped by 8,78%, 19,44% and 33,10% respectively. In Europe the Eurostoxx 50, DAX and CAC40 dropped 11,74%, 12,35% and 9,50% respectively. Slovenia's SBI index dropped by 16,46%. Only United Kingdom's FTSE index managed to close the year with a modest 0,91% gain. In Asia the Japanese Nikkei dropped 9,37% and Hong Kong's Hang Seng index fell by 15,46%.

 

In terms of industry sectors the telecommunications, consumer discretionary and technology sectors were hit the hardest. More precisely growth stocks such as Amazon, Alphabet, Tesla, Meta and the like were hit the hardest, which explains why the tech-heavy Nasdaq dropped by more than 30%. Value stocks generally suffered less damage. The big winner was the energy sector which stood head and shoulders above all other sectors with double digit gains.

 

Also bond investors generally had a bad year in 2022 as a result of central banks lifting their interest rates and consequently also bond yields: the longer the maturity of the bonds, the steeper the drop. Short-term bonds generally suffered smaller losses.

 

So where do we stand now and what to expect for 2023? First off, unless new geopolitical issues arise (or existing ones escalate), inflation will continue to cool down, especially when the monthly inflation spikes of April, June and July 2022 drop out of the annual equation. I expect overall inflation to be around 3% and core inflation (which is the key number for the FED) to be around 4% by the summer of 2023. The FED (and other central banks) are already slowing down their interest rate increases and any further increases are expected to be small and limited in number. With core inflation expected to drop below the interest rate set by the FED, interest rate increases should then also end. Some analysts are already speculating that the FED may even cut the interest rate in late 2023, but I have doubt that will happen because in my personal view the FED is always too late with their interventions.

 

Will there be a recession? Yes, probably, in the US as well as in Europe. The impact of the interest rate increases takes some time to take effect on the economy but will become clear this year. A better question however is whether it will be a hard landing or soft landing. A soft landing is obviously preferable and likely what the central banks are aiming for. A soft landing would essentially mean that technically we would be in a recession but it would be short-lived and barely noticeable in real life. The fact that the labor market is still very strong is an encouraging sign, although I do expect unemployment rates to increase this year, especially in the USA where it's still near a 5-decade low, which is simply not sustainable under these circumstances.

 

For the time being our aim is to stay in defensive stocks such as consumer staples, pharma and such while avoiding cyclical stocks, technology and other growth sectors. For fixed income investors bonds are now much more attractive than last year as they have higher yields and will be in demand by investors who prefer a »safe haven«. Precious metals (gold) should also continue to benefit from the economic uncertainties.

 

Happy and healthy New Year to you all from us at Primorski skladi.

 

Rudy Marchant
Fund manager Primorski skladi

 

Monthly reports - December 2022