Economic Insights for November 2022 A Record against What Actually Happened

The following was the economic insight for November 2022.  Global economic activity was experiencing sharp slowdowns in growth.  Inflation was running higher than in several decades.  The ongoing conflict in Ukraine, supply chain disruption, and lingering pandemic effects all pointed toward a negative outlook.  Most economists had already lowered their 2022 and 2023 GDP growth forecasts, while raising their inflation forecasts.

The Federal Reserve’s Trajectory

The Federal Reserve, and most advanced-economy central banks, were expected to hold a restrictive stance.  The Federal Reserve had just hiked rates by another 75 basis points to reach 3.75 per cent, with an apparent commitment to raise rates to 4.50 to 4.75 per cent by the end of the first quarter of 2023, a range well above neutral.  The prolonged hawkish stance had already triggered rising recession fears, judged overblown at the time.  This dynamic benefited the US dollar, treated as a haven asset.

China’s Divergent Path

The People’s Bank of China was far from hiking rates, amid weak domestic momentum.  The Chinese Communist Party was not prepared to risk a slowdown and preferred to ride out inflation instead.  The widening rate differential against the US forced the central bank to pause easing and hold rates steady.  China’s economy had rebounded in the third quarter, though a strong long-term recovery faced real challenges from the property crisis, strict zero-Covid controls, corporate bond default risk, and global recession exposure.

The Portfolio View at the Time

Asset allocation remained the dominant driver of portfolio outcomes amid volatile markets.  Fast-paced rate hikes, rising recession risk, and potential unemployment increases across developed markets argued for staying underweight equities, being cautious on bonds with a preference for lower duration, and building a larger cash allocation, positioned to buy opportunistically once valuations dropped to attractive levels.

Underweight equities remained the recommendation to mitigate downside risk, with weaker macro conditions and a higher risk premium keeping expected returns low, driven by valuation derating rather than earnings collapse.  A neutral stance on Asia excluding Japan was recommended, given local central banks turning hawkish amid multiple external headwinds, with China treated as the exception.  Caution on credit, particularly high yield, was recommended, with spreads expected to widen further amid slowing growth and weaker corporate results, favouring short-maturity credit for its lower rate sensitivity.  Aggressive Federal Reserve tightening had already flattened the yield curve, with short rates rising faster than long rates, and higher rate volatility and weaker bond price performance were expected to continue over the medium horizon.

What Actually Happened

The Federal Reserve’s own trajectory ran further than this report anticipated.  Rates reached 4.25 to 4.50 per cent by December 2022, close to the forecast range, but continued rising through 2023, eventually peaking at 5.25 to 5.50 per cent by July 2023, the highest level in 22 years.

The yield curve inversion this report described continued deepening through 2023, and while a full recession never materialised in the US, banking stress arrived instead: Silicon Valley Bank and Signature Bank collapsed in March 2023, followed within days by Credit Suisse’s forced takeover by UBS, a crisis traceable to the pace of tightening.

China’s own listed risks proved accurate and then some.  Zero-Covid controls held rigidly through 2022 before Beijing abandoned the policy abruptly in December, following nationwide protests the previous month, a considerably more chaotic reversal than gradual policy easing.  The property crisis deepened for years afterwards, with Evergrande’s liquidation only finalised by a Hong Kong court in January 2024.  The underweight equity call held through the remainder of 2022, with the S&P 500 finishing the year down 19 to 20 per cent, its worst year since 2008, before a sharp recovery through 2023 rewarded anyone who stayed underweight.

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Terence Nunis | Executive Chairman, Equinox Zenith | Author, The 1% Playbook: The Billionaire Cheat Code