2022 was a year of volatility in investment markets due to the appearance of risks that we haven’t seen in decades - inflation, war in Europe, and rapidly rising interest rates. It was a tough year for investors in almost all markets and will likely be a period that people look back on and analyse for decades to come. But what are some of the investment lessons we can take from 2022, and what are the signs of improvement we’re seeing as we look to 2023 and beyond?
Markets are constantly evolving and the risk factors that drive them are always changing. While the market’s focus is constantly shifting, the lessons we get taught are often similar. As a result, investors can benefit from reviewing the past, learning lessons, and trying to avoid making the same mistakes twice. While there are lots of potential lessons from 2022, there are two that really stand out to us.
1. If it sounds too good to be true, it probably is
This is a lesson that has been learned time and again and may be one of the most painful for many new investors.
In recent years many investors have been drawn into the market due to the rise of retail investment platforms and cryptocurrencies. When your friends are making ‘easy money’ on the newest hype stock or coin, the fear of missing out (FOMO) can lead usually prudent individuals to speculate on high-risk assets. When prices are rapidly rising, investors can latch onto this and become overly optimistic about how a company may perform - rather than focusing on fundamentals like the company’s assets and income.
There was once talk about Bitcoin being the ‘future of money’, Peloton being the ‘future of fitness’, and Robinhood being the ‘future of share trading’, but this proved to be unrealistic and their prices have fallen drastically from their highs.
The most recent example of this speculation and lack of due diligence can be found in the downfall of cryptocurrency exchange FTX. The founder and former FTX CEO Sam Bankman-Fried, was arrested and jailed in the Bahamas on December 12th in connection with alleged fraudulent activities – with the collapse losing investors billions of dollars, not all of which will be recovered.
Unlike investors who use transitional share brokers and exchanges, users of FTX were not afforded the same protections in the form of regulation, audit requirements, capital requirements, and rules against related party lending.
Had investors in both FTX and FTT done their research rather than focusing on the money others were making, they may have realised it was a bit too good to be true.
2. Inflation is never dead, just resting
Although we haven’t seen high inflation like we’ve had this year in over three decades, it’s always something to consider when choosing how to invest, particularly for retirees.
The risk is always present that governments around the world will spend more than they should to prop up their economies, and in doing so cause inflation. There is also always the potential for supply shocks after major events such as wars, pandemics, and other natural disasters that can contribute to inflation. During 2022, a combination of supply shocks, increased government spending, and loose monetary policy have led to the high rates of inflation that we are seeing today.
Inflation can be a particular problem for retirees that may need to live off their savings for another 30 years. The Reserve Bank of New Zealand (RBNZ) is currently hiking interest rates to try and get inflation under control, but even if they do rein it in, inflation of just 2.5% per annum will see the value of a dollar halve over 30 years.
The graph below shows the gradual decline of the purchasing power of one dollar in New Zealand between 1972 and 2022. The value of the dollar fell a staggering 90% over this period. This illustrates the importance for retirees to consider allocating a portion of their savings to growth assets or higher yielding bonds, which can help mitigate some of this decline in purchasing power.
Why we’re optimistic long-term returns are improving
After an investing year as difficult as 2022 has been, worry and pessimism are understandable. It’s also important to remember, however, that it is often darkest before the dawn. Every major bull market has been preceded by a bear market. And often the bigger the bear market, the bigger the subsequent rebound. The flipside of a bad year is the prospect of a rebound and better returns in the following years.
After every decline larger than 25% in the US S&P 500 Index, there has almost always been significant positive returns in the following year. And on a three-to-five-year view, returns have always been positive - often materially so.
This outlook is also supported by JP Morgan’s recent conclusion from its 27th annual capital market assumptions report. While predicting short term market direction is nearly impossible, making long term (10 year plus) predictions are more reliable. JP Morgan’s return estimates for equities and bonds have jumped significantly over the last year. Its return prediction for a broad US fixed income portfolio for the next 10 years has jumped from 2.6% per annum to 4.6% per annum. For US large cap stocks, JP Morgan’s return expectations for the next 10 years have almost doubled – rising from 4.1% last year to 7.9% this year.
So, if you have a long-term time horizon – which most people should (even many retirees) – return expectations have now improved to a point where they look the most attractive in a decade.
While investment lessons are often framed in terms of avoiding loss, it’s important to remember that the best buying in markets often comes when uncertainty is at its highest. Selling and moving to cash when pessimism is high is seldom a winning strategy.
So while 2022 has been a unique and challenging year for investors, we see plenty of opportunities ahead, and good reason to be optimistic for 2023 and beyond.