Markets in 2022: the year in review

At the start of 2022, many investors were looking forward to a benign year of economic and financial market recovery after the privations of the pandemic. Then Vladimir Putin launched his attack on Ukraine and the landscape changed irrevocably. 2022 has been defined by soaring inflation, rising energy prices and chronic instability. It has been a year that most would rather forget.

Russia supplied much of the world – and Europe in particular – with fossil fuels. Many governments have spent much of 2022 scrambling to disentangle themselves from their dependency on Russian oil and gas. At the same time, Ukraine was a significant supplier of agricultural products. The war has halted exports and impacted cultivation and harvesting. Overall, the result has been a huge spike in the price of

The war has prompted a profound rethink in the way governments source and use energy. While some governments have temporarily increased their use of alternative fossil fuels, such as switching coal stations back on, it has given greater impetus to renewables. Countries have recognised the need to be self-reliant, rather than importing energy from unstable regimes around the world. Their resolve may have been hardened by the response of OPEC to the crisis, which has refused to play ball on bringing more oil to market.

The result has been significant commitments from the world’s largest nations on shifting their energy mix. In the EU, the RePower EU plan puts clear plans in place to reduce the region’s reliance on Russian gas and boost the use of renewables. In the US, the Inflation Reduction Act passed in August, brought in significant incentives for renewable energy projects, including hydrogen, plus support for electric vehicles. China’s Xi Jinping has also reiterated his commitment to renewables.

The pandemic created bottlenecks in global supply chains. While the impact of the pandemic has ebbed for many countries, for much of the year these supply difficulties were not resolved. China’s zero Covid policy meant it was subject to periodic lockdowns, which also proved disruptive. The problems need to be set against a wider re-engineering of global supply chains to bring them closer to home.

The result has been chronic and entrenched inflation for many countries. Inflation has been hovering at up to 9-10% in the US, UK and Europe and has continued to defy central bank expectations. While inflation was initially driven by energy prices, it has spread to the wider economy as companies have sought to recoup higher input costs. There are signs that it is now spreading from goods to services as wage pressures increase.

Central banks have been forced to act swiftly, raising rates at pace. The US Federal Funds rate moved from 0-0.25% at the start of the year to 3.75-4% by the start of November. Other central banks around the world have followed suit. The Bank of England increased the UK base rate to 3% in early November, while at the end of October the European Central Bank set its rate at 1.5%. The only notable exceptions have been China and Japan, where inflationary pressures have not been as acute, giving their central banks greater flexibility on monetary policy.

Relations between the US and China were already deteriorating and China’s tacit support for Russia in the current crisis has exacerbated tensions. Europe now has war within its borders, which has created a new fragility. There has been a stark realisation of the limits of globalisation – with governments and the corporate sector retreating, re-routing supply chains and shoring up friendly allies.

This has been felt in financial markets in 2022. It has prompted a collapse in confidence in the Chinese market from international investors, for example. It has seen the US Dollar restored as a ‘safe haven’. The UK has shown how financial market trust can be destroyed by a single misstep – and the extent to which politics still matters.

The Bank of England said the UK would see the longest recession since the 1920s. In the US, Goldman Sachs said recession was not a ‘slam dunk’, believing the Federal Reserve could pull off a soft-landing, but many other economists see it as an inevitability. Markets have increasingly priced this in over the course of the year. 

The fixed income market has been tough for much of the year as interest rates have risen. Government bonds have proved the opposite of a ‘safe haven’, with yields rising significantly (and prices falling). The yield on the 10-year US treasury had moved from 1.6% at the start of the year to 4.2% by early November. The UK saw gilt yields spike in the wake of Liz Truss’s failed fiscal experiment.

This shift in fixed income markets has had a significant effect on equity markets, alongside widespread risk aversion. There has been a rotation from growth to value, as higher bond yields changed the valuation metrics for many high-growth companies. In particular, there was a notable sell-off for the previously highly prized technology companies. Income stocks came back into vogue, as inflation meant that cash today was worth more than cash tomorrow.

However, in reality, there were relatively few safe havens. Commodity companies did well on the back of rising prices. Infrastructure, particularly renewable infrastructure, proved resilient. India was a surprising positive, as strong growth and relatively low inflation made it an economic hotspot. It was a particularly tough year to achieve diversification, with bonds and equities falling in tandem. The gold price rallied at the start of the year but has been relatively static since March.

Investors will be hoping for a better year in financial markets in 2023, even if the economic reality may be worse. Markets have fallen a long way and a lot of bad news is in the price of assets. However, recent years have shown that a new and unimagined crisis may be just around the corner.

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