2022 Portfolio Reviews

"Periods of uncertainty are always uncomfortable, but these are the periods to remain resolute, look for opportunities and continue to focus on the long term."

By Portfolio Advisor Paul Sedgwick

Dear Partner

Review of the year

What a year it has been. The list of noteworthy events seems almost endless. The loss of our glorious Monarch after 70 years on the throne, alongside the human suffering as a result of the Russia/ Ukraine conflict being the most noteworthy, and saddest. Over 30 trillion dollars was lost in the capital markets in 2022, according to a Financial Times report. The S&P 500 fell 20% during the year. All things considered, it could have been worse, as central banks around the globe grappled inflation rates becoming more embedded than they anticipated at the start of the year. The Federal Reserve anticipated raising interest rates by 1% in 2022. By the year end they implemented one of the most aggressive tightening cycles in history. US interest rates started 2022 at 0.25%, and are currently at 4.25% and forecast to go to at least 5% before they peak. They were not the only Central Bank to engage in tighter monetary policy as the globe felt the effect that Covid shutdowns had on supply chains alongside the impact Russian sanctions had on energy prices. For many years the S&P 500 has been supported by Central Bank policy during periods of uncertainty, which became known as ‘The Fed Put’. That pattern clearly ended in 2022. In contrast, this year the Fed kept its foot on the monetary brake pedal, despite a weakening outlook. Helping support the US economy was the resilient consumer and the strength of the labour market, however this reinforced the Fed’s hawkish stance.

It has not been much of a year for all asset prices, as equities, bonds, long dated index linked gilts, and credit all fell, along with the greatest fall from grace, Crypto. It feels that bubble has well and truly burst, and the emperor finally revealed to have no clothes. During periods of inflation and uncertainty, gold is considered a safer asset and, to some degree, it did provide that role, finishing the year pretty much where it started. Technology shares were the hardest hit of the established indexes as the Nasdaq still fell over 30%, despite having recovered from its lows. Elon Musk’s acquisition of Twitter resulted in a dramatic fall of the Tesla share price, as seven days of straight losses resulted in a 60 pct drop in the price in the final quarter. This was not the only highly-rated technology company to suffer, as many other household names and darlings of the past few years had a similar fate.

It was an eventful year in British politics, resulting in three different prime ministers and no General Election. The British economy feels in a precarious state. The Bank of England struggled with a weakening economy, the tightest fiscal policy for over 50 years, and inflation running at 10% year on year. As a result, many industries demanding large wage increases, at a time when the government can least afford them, which could further stoke inflation in the coming years, if awarded. Despite all this, the FTSE 100 outperformed its many peers in 2022, largely because of its lack of exposure to tech and its relative exposure to commodity prices.

Portfolio

All our portfolios outperformed their relevant peer-groups in 2022 and in doing so, were able to increase their long-term outperformance (see performance). The stocks in the Total Return and Total Return Equity portfolios that tended to hold up better than others were those that have pricing power in periods of inflation, including Coca Cola (+7%), Johnson and Johnson (+3%) and British American Tobacco (+20%). Other outperformers on the year were Burberry (+12%), as investors warmed to the new CEO, RIO on resilient commodity prices, and oil stocks that benefited from energy prices - Shell was no exception (+63%). Obviously, we had some losers during the year; Walt Disney (-44%) suffered as streaming services came under pressure, however, the return of Bob Iger seems to have restored some investor confidence.

We added two new stocks to the portfolio this year, Estee Lauder, the global cosmetics brand, and Texas Instruments, a leading manufacturer of semiconductors. PayPal suffered as the world derated technology companies, at a time when consumer spending slowed, and competition increased. We still have conviction in these companies as they remain world leaders in their fields. PayPal has a strong balance sheet and valuations are now far closer to broader index norms. THG was the obvious weakest holding this year. Although it was never a significant holding, we were slow to react when management changed tack. One performance of note has been Merck, up over 40% year to date on higher than forecast revenue growth after a strong performance from its oncology franchise.

For many years, we held more cash than one would, as we saw little value in many fixed income markets. The sudden fall in government bonds in the second half of 2022 gave us the opportunity to deploy that cash in an efficient way. Towards the end of the year, we added a range of UK gilts to the portfolio, with maturities ranging from six months to two years. All were at prices below par, and as capital gains in gilts are not subject to tax, this made them even more attractive. Whilst these gilt opportunities exist, and our holdings mature, we will continue to roll into future years, whilst maintaining the short duration.

Outlook

There is no doubt that sentiment remains negative for the coming year. It is hard to find an optimistic strategist for at least the first half of the year for stocks, as most prefer government bonds, which should benefit from inflation rates falling, and weaker growth. The crux of their argument is that a major part of the correction this year has been as a reaction to rising bond yields, making equities less attractive, as the equity risk premium narrowed. Analysts have been slow to react to a weakening economy, and therefore remain too optimistic coming into this year. As earnings fail to meet expectations, stock prices will further derate as valuations remain relatively high. Others point to the fact that, despite periods of volatility, we have not seen the peaks in the Vix that signal true capitulation from equity investors. It is noteworthy that as we enter the New  Year the Vix index has tracked back close to its long-term average. There has been a recent divergence in the S&P 500 and the Vix.

Many investors are looking for the moment the Fed pivots away from its hawkish stance and have taken recent comfort from the latest meeting of the Fed that resulted in just a 50-basis point rise. Ian Hartnett from ASR points out that the moment the Fed pivots is not the point when stocks start to rise, but often is the catalyst for another leg down in stock prices. So, a more dovish Fed may be a false dawn for stock prices.

On the plus side, investor surveys suggest that portfolio managers are well positioned for falling stocks, as they remain overweight cash relative to history. Fed funds are expected to peak at over 5%, so we may be nearer the end than the beginning of the Fed tightening cycle. The US economy is forecast to grow around 4% at an annualised rate in the fourth quarter of 2022. This could help underpin fourth quarter earnings, which start to be released in early January. At present analysts are forecasting negative earnings growth for Q4 2022 relative to Q4 2021.

China has now completely unwound its zero Covid policy, to stimulate economic growth in the region, which has suffered mainly because of the policy. Stock markets and the US dollar have been closely linked this year, and this may well remain the case for the coming year. We have seen how the US dollar has given back around 10% in the last quarter and has resulted in a modest recovery in stocks. The ongoing conflict between Russia and Ukraine may not make the headlines it once did, but sanctions imposed on Russia have a negative impact on the wider global economy as we have seen this year. Any cessation of hostilities that resulted in an easing of those sanctions would provide some stimulus. Consensus expectations for US economic growth have been lowered in 2023 to just over 1%. That may give room for growth to surprise on the upside. Inflation forecasts are falling rapidly as long-term expectations remain anchored close to 2%, the Fed target.

Periods of uncertainty are always uncomfortable, but these are the periods to remain resolute, look for opportunities and continue to focus on the long term. As Jeremy Siegal clearly demonstrates in “Stocks for the Long Run” the longer you hold quality companies the less risk you take, the longer you hold bonds the more your capital is eroded by inflation. We will maintain our disciplined approach and continue to seek out the right opportunities.

Yours sincerely

Cube Capital