Lessons from 2022

What a roller coaster 2022 has been !!!

The year commenced with the Fed acknowledging that inflation is not transitory, and indeed, prices rose at the fastest pace in four decades before topping out at 9.1% for June. Many economists have termed Fed's transitory inflation call among the worst in its history.

Russia/Ukraine war and Quantitative tightening, where the Federal Reserve is reducing the size of its balance sheet by $95 billion per month, compounded the woes of financial market participants even further. The supply chain disruption due to China lockdowns and commodity volatility also boxed investors into a corner.

What essentially were tailwinds in 2021 became headwinds for investors in 2022

If previous years were characterized by Fed adding liquidity, 2022 saw it draining money away from the system. Furthermore, the most aggressive pace of rate hikes was done by Federal Reserve this year. As a result, US 10-year treasury yields rose from 1.51% in January to 4.33% in October.

The rising cost of money has seen the SPX 500 fall by 15.4% this year. Technology bellwether Nasdaq 100 dived 28%. On the other hand, ARK Innovation ETF, the favourite of growth stock investors, got battered by 63%. As is often the case, technology and growth stocks get hammered the most when interest rates rise since most of their cash flows happen at a future date, pulling down their valuations.

From a technical perspective, the markets have already entered a bear market which is typically challenging for most investors

Subsequently, when prices are declining, it's pertinent to have a diversified portfolio which consists of stocks, bonds, commodities, REITs etc. This might sound counterintuitive, as 2022 was among the worst for 60/40 stock/bond portfolios. But this could be a one-off event, and it's worth noting that such a portfolio would be much safer than one exposed only to growth stocks.

Bonds are a haven, and with inflation's peak likely behind us, they may rally again as markets price in a recession. And again, diversification doesn't mean just buying one index. For example, in SPX 500, Apple, Microsoft, Amazon, Alphabet and Tesla account for more than one-fifth of the total weightage, meaning the index is highly concentrated. A proper portfolio of ETFs can enable diversification.

Heightened volatility is the most prominent problem investors have had to deal with this year

But then, bear markets tend to be more violent, and they witness sharp counter-trend rallies also. Market participants should be alert and have a disciplined long-term strategy to avoid getting caught up in short-term trends.

Typically, one sector (or more) always emerges as the winner in a bear market. In 2022, energy, materials, industrials, and healthcare were among the outperforming sector. Nonetheless, if the economy moves into a recession, it might not continue its outperformance. So, investors always need to take a look at the complex data.

In a nutshell, investors should be impassionate with their analysis and be prepared to rebalance their portfolios as needed.