Overview
2021 was relatively quiet in terms of major global and investment events, at least based on what we looked at in our previous discussion. COVID remained a primary concern in the minds of many investors, and rising sentiment surrounding climate-related targets also gained more momentum.
Equipped with the gift of hindsight, we can now look back on 2022 with clear eyes and see that it also contained its fair share of notable events. Arguably, 2022 proved to be much more eventful. As COVID fears were finally starting to subside, new, unexpected events were quick to catch the world and investors off guard.
As always, this article won’t go over every single thing that happened over the course of the year. Rather, we will look at some notable events that attracted a lot of attention and understand how they affect investors, either now or in the future.
Russia/Ukraine War
When talking about a major event that happened in 2022, the thought that comes to mind for many people will most likely be the Russia/Ukraine War. Soon after Russia started its “special military operation” in late February, the global community was quick to respond, whether it was taking in refugees from the war or businesses leaving Russia en masse.
Unsurprisingly, financial markets were also just as quick to respond to the conflict too. Findings show that although markets around the world were negatively impacted, not all were affected to the same extent. Countries in Europe and Asia were the most affected, whereas countries in North America, the Middle East, Latin America, and Africa weren’t as affected to the same degree.
Investors can glean two important lessons from this.
First, we see that major conflicts, particularly at their onset, are a major source of volatility. Even before the conflict started, markets were already growing wary. After all, nobody knows how any conflict will unfold and what changes will happen as a result of it, so emotions running high and fear taking hold is to be expected.
However, this doesn’t mean investors should start panicking – not every investor’s portfolio will be affected by the conflict, and if it is, their best bet would be to follow the conflict’s developments as best they can and not to make any rash, emotionally-driven decisions.
Second, this is a reminder to investors who want to expand their investment horizons overseas that some risk factors that would’ve seemed unthinkable in their home/primary country may need to be considered if they wish to commit capital in a new country or region, and failure to properly account for those risks may prove to be a big mistake.
War, political upheaval, and energy crises may seem like farfetched risks in the eyes of a Canadian investor, but if they were to one day enter Asian markets then those risks suddenly become a very real possibility.
Market uncertainty and the re-introduction of certain risks are all major takeaways from this war, but there are a few more lessons we can extract from this.
In terms of its economy, Russia is known for being a major oil & gas and fertilizer producer (natural gas is a major input in nitrogen-based fertilizers). As the conflict went on throughout 2022, economic sanctions were imposed on Russia that tried to stop the flow of certain exports, namely their fertilizers and hydrocarbons.
As the conflict went on, economic sanctions against Russia and retaliatory supply cuts to European countries resulted in major volatility in global energy markets, with oil exceeding $100/barrel at the peak of all this volatility. Because natural gas is a major input in fertilizer production and given that natural gas markets were highly volatile, fertilizer prices also surged.
This rapid increase in energy prices was felt by consumers, and all of a sudden many people found themselves struggling to pay rising energy bills, with the U.K. being hit particularly hard.
While rising energy prices negatively impacted millions of people, this wasn’t to say that it was a negative experience for everyone.
Record-high oil prices meant that oil producers could stand to gain a lot from this ordeal, and they certainly did. In 2022, Big Oil (Exxon, Shell, and BP, to name a few members) saw their profits double compared to the previous year. Similarly, Canadian oil producers also enjoyed record profits due to high oil prices. Shareholders of these companies also benefitted nicely, whether it was a surge in stock price, generous dividend increases, or even both.
From an investor’s point of view, this is fantastic news: no sensible investor would complain that a company they have in their portfolio is making too much money, especially when a sizeable portion of that money ends up in their own pockets via dividends or capital gains.
However, it would be wise for investors to ask how this record profit was achieved, as we’ve discussed before. It’s clear that the record profits that oil companies enjoyed in 2022 were the result of a black swan event, not organic industry or demand growth. Once the Russia/Ukraine conflict has sorted itself out and energy markets finally stabilize, it’s unlikely that the same blockbuster profits will be seen again.
Investors and speculators alike who rode this industry high and expect it to continue indefinitely may be in for a nasty surprise when energy markets eventually stabilize and energy prices return to what they were previously.
Record-High Inflation
Other than the Russia/Ukraine conflict, there was another big thing on many people’s minds: inflation. Unlike the war, this rapid inflation was a global phenomenon and affected nearly every country.
As the cost of food, energy, and other common items sharply increased, and with many people on the verge of financial collapse, central banks stepped in to try and avert potential disaster. How? By increasing benchmark interest rates.
Warren Buffett once said that interest rates serve as a damper on equities: the higher interest rates are, the lower equities prices are pushed. But why is that?
Though he never fully explained it himself, the possible reason may be due to what interest rate changes hope to achieve.
When central banks want to boost economic activity, they lower interest rates. By doing so, they hope to promote borrowing, and in turn, encourage spending, ultimately ramping up economic activity. On the flip side, banks raise interest rates to discourage borrowing, subsequently leading to a decrease in spending, and ultimately, a cooling down of the overall economy.
From an investor’s point of view, low interest rates serve to promote business growth, and as a result, stock prices will likely trend upwards. Because high interest rates are meant to dampen the economy, businesses will likely see a decrease in activity/revenue, and in turn, push their stock price lower.
So, what lesson can investors learn from the record-high inflation we saw in 2022?
This was a clear demonstration that, sometimes, there are forces that are well beyond an investor’s control but will end up affecting them anyways. Investors had no control over how this inflation would ultimately unfold, nor did they have any say as to how aggressively central banks chose to combat it.
Investors can only control so much and for the most part, these controllable factors can greatly influence their portfolio’s performance. However, the bitter reality is that investors can’t control everything, and the sooner they accept this, the sooner they can stop needlessly stressing over things they ultimately cannot change or influence.
Growing Fears of a Recession
As the Russia/Ukraine war continued to rage on, and as inflation remained stubbornly high despite aggressive interest rate hikes, a certain question started to appear in the minds of many people: is a recession bound to happen?
Throughout 2022, there was no shortage of discussion from all sorts of pundits, commentators, and news outlets about the possibility that a recession would arrive any day – a quick Google search can easily show this.
In fairness, this speculation wasn’t completely unfounded: as interest rates stayed high throughout the year to try and combat inflation, economic activity was more muted. On top of that, people still weren’t sure how the Russia/Ukraine war would ultimately play out, and how the consequences of the war would affect the global economy.
So, it comes as no surprise that financial markets slumped throughout the year whenever the word “recession” started to enter the investor lexicon again (Examples 1, 2, and 3, to show a few).
Notice how financial markets and investor confidence dropped precipitously not because a recession was officially underway, but because the fear of one arriving was ever-present. It’s easy for virtually anyone to claim that a recession is coming, but it’s very hard, if not impossible, to know when exactly it will show up, how severe it will be, and how long it will last.
Even now, at the time of this writing, there is still ongoing speculation that a recession will hit in 2023, but that’s a discussion we’ll save for 2023’s Investment Lessons article.
Nothing destroys an investor’s rational thinking faster than fear, whether this fear will ultimately turn into something tangible or not. Not only that but just because a lot of people are fearing that something might happen doesn’t necessarily mean that it will. The repeated slumps throughout 2022 because of the anticipation of a recession were a perfect demonstration of that.
Investors who realized this was nothing more than empty noise and stood their ground would’ve left 2022 in a much better position than those who bought into the fear and turned their portfolios upside down because of it.
UK Government Crisis and Market Meltdown
Day-to-day political affairs usually don’t affect financial markets. It’s true that markets may react to the aftermath of major elections (namely the U.S. election) or after certain legislation has been introduced, but other than these high-profile events daily market activity isn’t heavily influenced by daily political dealings.
Sometimes, however, certain political developments become so big and garner so much attention that financial markets can’t help but notice them, and if these developments become really big, then markets get dragged into the fold, for better or for worse.
In 2022, this was on full display during the UK’s Government Crisis and subsequent market meltdown.
(Very) long story short, the government crisis began when, in September 2022, the UK Government introduced its mini-budget, widely known as “The Growth Plan”. It was given this name because it aimed to promote economic growth in the UK, and the budget planned to do that by introducing a flurry of tax cuts to the tune of 45 billion pounds.
So, what was the problem behind this contentious budget? Those tax cuts were unfunded, or in other words, there was no other source of revenue that would make up for the lost tax revenue. The plan was to increase government borrowing to fill the revenue hole that would be left behind, and they intended to do so by issuing more public bonds. In other words, the plan was to take on more debt.
Given that interest rates were already sky-high due to record inflation, and the idea that the government would take on more debt to fund their aggressive tax cuts, this news wasn’t exactly taken very well. Bond markets were quick to react, and the British pound fell sharply as the potential consequences of the mini-budget became increasingly clearer.
As the markets descended into chaos, the pound continued to weaken, and as the government’s credibility was called into question, many of the propositions in the mini-budget were scrapped a few weeks later.
There are a plethora of lessons to be learned from this ordeal depending on what point of view you choose to study it from. But for our purposes, when looking at this strictly from an investment point of view, there’s one lesson in particular that stands out: sometimes, all it takes are a few actions from a government to cause major market upheaval, and frustratingly, investors can’t do much to influence or control those actions.
Many investors are quick to disregard political risk and treat it as something that should only be taken seriously in developing nations. However, the fiasco that happened in the UK proved that political risk is something that can also materialize in developed nations too, and this risk is something that can materialize seemingly out of thin air.
Political risk is more than just the possibility of a government collapsing or rampant corruption getting out of hand. It also includes the possibility of governments introducing new legislation or budgets that, although they sound great in theory, end up being terrible in practice.
Wrapping Up
2022 was arguably the first year where investors could finally stop worrying about the effects of COVID. However, when one problem or worry seems to have subsided, new ones are just as quick to appear. As 2022 unfolded, it was clear that were plenty of lessons that investors could learn from this hectic year.
Whether it was the Russia/Ukraine War, record-high inflation, or failed mini budgets, so many events were quick to turn financial markets upside down.
Unsurprisingly, many investors were quick to abandon their logical thinking in favour of riding on the wave of mass hysteria. Time and time again this behaviour is observed, and 2022 was no different.
Going forward, it will be interesting to see what the effects of sustained, high inflation are and if the fears of an impending recession will eventually come true.
