It has been said that everything old is new again. We find it hard not to have mixed feelings about this old trope when reflecting on 2022.
Year-End 2022
The year represented a giant step toward normalcy for many of us after a long period of routine lost to the pandemic; going to the office, a restaurant or a sporting event without restrictions still has a whiff of novelty to it. At the same time, there were a number of recurrences we could have done without, including double-digit inflation rates, stagflation, potential energy shortages, Russia as the chief antagonist of the West and loose talk of nuclear engagement.
Noting the similarities between the current environment and times past, we recently reviewed the Global Value team’s published materials from the past couple of decades. For us, this look back in history served not only as a reminder of the circular rhythm of the markets but also of the consistency of the investment approach introduced by the now-retired Jean-Marie Eveillard. As the current stewards of his philosophy, we carry on his tradition of constancy in the face of shifting dynamics and of focus on avoiding the permanent impairment of capital independent of the
markets’ whims.1
We believe the market and macroeconomic dynamics we witnessed in 2022—while painful—reflected a relatively orderly transition from an environment characterized by a generational-low cost of capital to one in which money again has a price. For many years, repressed interest rates helped support valuations for securities with expected cash flows far into the future and contributed to a prolonged period of outperformance of growth stocks. This came at the expense of value stocks, which tend to focus on free cash flow in the here and now. The rise in interest rates during the course of 2022 as central banks worldwide sought to tame inflation—yield on the 10-year US Treasury, for example, increased by more than 230 basis points during the year2—explains much of the drop in securities dependent on future cash flows. The math of higher discount rates exerted itself.
While equities were weak across the board in 2022, lower-valuation stocks turned the tables on growth
names; the MSCI World Value Index outperformed its growth analog by more than 2,250 basis points last
year.3 Geographically, non-US stocks held the edge last year, an infrequent occurrence during the the post global financial crisis period. Despite 2022’s relative outperformance, the price ratio of non-US stocks to US names remains at lows not seen in many decades, as shown in Exhibit 1. We think one ought to be open minded in such an environment, especially given the number of quality businesses that exist outside the US.
Exhibit 1. Non-US Stocks Trading at Multi-Decade Lows Relative to US Stocks
Price Ratio of MSCI EAFE Index to S&P 500 Index, January 1970 through November 2022
Source: Bloomberg; data as of December 31, 2022
Unfortunately, the long period of low—and sometimes negative—nominal rates served as fuel for a range of more speculative investments, many of which suffered profoundly during 2022 as rates reversed course. For example, the ARK Innovation exchange-traded fund—a multi-cap vehicle whose theme is “disruptive innovation” and that could be considered a proxy for the tech high-flyers that bloomed in the aftermath of Covid-19—was down 67% in 2022 and nearly 80% since its peak in early 2021.4 The value of special purpose acquisition company (SPAC) initial public offerings in the US fell 90% year-over-year in the first three quarters of 2022, and the value of “de-SPAC” transactions (in which the previously IPOed SPAC merges with its targeted private business) declined 89%.5 Cryptocurrencies lost about $1.4 trillion in market capitalization,6 and a number of headline-grabbing missteps—including the high-profile bankruptcy of crypto exchange FTX and the de-pegging of stablecoin TerraUSD—inspired calls across jurisdictions for greater regulation of the industry.7
Meaningfully positive real interest rates also fueled a selloff across the fixed income complex, with duration-sensitive issues particularly challenged. The Bloomberg US Long Treasury Index was down about 29% in 2022, while the index of long global sovereign debt posted a similar loss. Corporate bonds fared better, but investment grade and high yield debt still delivered double-digit losses.8 With borrowers given pause by higher rates and investors seeking to preserve liquidity in a volatile environment, new corporate issuance fell sharply in 2022 after establishing fresh annual records in 2020 and 2021.9 A very active primary market has been a key support of performance in recent years, particularly for high yield bonds; continued weakness here could become a more systemic concern should issuers find their access to the capital markets limited when it comes time to refinance maturing paper. That said, borrowers were aggressive in issuing low-rate debt in the preceding years, and the manageable near-term maturity wall suggests a decent amount of breathing room for most.
On the flip side of this bond rout is that many fixed income securities now offer investors reasonable yields, freeing them from the idea that there is no alternative to equities. However, credit spreads on both investment grade and high yield corporate bonds in the US counterintuitively rebounded to levels above their long-term averages on a yield-to-worst basis, before pulling back somewhat toward year-end.10
We see the potential for additional downside in credit from here, especially if the Fed’s inflation-fighting fervor tips the economy into recession. Inflation alone weighs on margins and pressure credit metrics, inflation plus slow or no economic growth would amplify these effects. Conditions could get truly messy if markets were to lose faith in the Fed’s ability to control inflation and the “bond vigilantes” stepped in to drive up rates. We saw a preview of this in the UK during the fall; the Truss administration issued a highly stimulative—and since-scuttled—budget proposal at odds with the Bank of England’s inflation-fighting efforts, quickly sending the pound to a record low against the dollar and 10-year gilt yields to levels not seen since 2010.11
Many of our portfolios hold gold as a potential hedge against adverse market outcomes. The price of gold behaved pretty much as we would expect in 2022. It rallied early in the year in anticipation of and the weeks after Russia’s invasion of Ukraine as investors sought traditional “safe havens.” With markets digesting tighter monetary policy, however, gold moved lower as real interest rates—the key determinant of movements in the price of gold—moved higher. A rebound ensued toward year-end on signs the Federal Reserve was prepared to slow its pace of rate hikes, and ultimately spot gold lost only 28 basis points in 2022 despite significant intra-period swings.1
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