First of all, we wish all our readers a Happy New Year 2023. The start of a new year is usually a time for reflection, on events that transpired over the past year, and the making of new resolutions to do better in the year ahead.
For the majority of investors, the year 2022 was a bruising one, whether one is invested in traditional stocks and bonds or funky assets such as cryptocurrencies and meme stocks. A case in point: US stocks alone lost some US$12 trillion in market cap, the worst drop since 2001, with the S&P 500 index down by more than 19%. Growth, and in particular technology, stocks fared the worst — the Nasdaq Composite was down 33% for the year.
Bonds, usually the dependable ballast to stocks, and a perceived safe investment, also fell sharply. The Bloomberg US Aggregate and Bloomberg Global Aggregate indices fell 13% and 16% respectively, the worst declines since 1978 (see Chart 1). Meanwhile, far from being the touted hedge against traditional asset price movements, the market cap for cryptocurrencies fell from a peak of US$3 trillion in November 2021 to less than US$800 billion by end-2022. The collapse is marked by several high-profile crypto asset failures, including the Terra stablecoin death spiral and bankruptcy of one of the largest crypto exchanges, FTX.
On the heels of such drastic losses, one would expect that this year can only get better. But the truth is, dispersions for current forecasts are massive, suggesting that investors are really at a crossroads — and it could go either way. We foresee 2023 to be a year of great uncertainties and, therefore, volatility in asset prices.
As we have written many times before, successful long-term investing is not only about maximising profit but also managing the risks. As with everything in life, there is a necessary trade-off between risks and returns. This is also why the appropriate performance measure for any portfolio (or investment) is not simply the headline returns, but its risk-adjusted returns. That is, the portfolio’s returns after taking into the account the risks undertaken to achieve those returns. For example, a portfolio return of 20% does not mean it has done better than one with 10% returns, not if its risk is substantially higher. There are a number of popularly used measures for risk, including alpha, beta, the Sharpe ratio and standard deviation.
For the better part of the last decade, stocks have risen against the backdrop of falling interest rates — culminating in the longest bull market in US history, ended only by the pandemic in 2020. A rising tide lifts all boats and, for many, risks became an afterthought. But when the tide turns, as it did last year, the riskiest assets suffered the biggest losses! Surely a timely lesson.
The US Federal Reserve’s aggressive interest rate hikes have been the key driving force behind the decline in stock and bond prices in the past one year. The worst of the interest rate increases, we believe, is behind us — though the market is still expecting rates to peak at some 50 basis points below the Fed’s median projection of 5.1%. In other words, if the market is wrong, then yields will have to rise — and stocks-bonds will have room to fall further.
More importantly, we think, 2023 will be about the impact of last year’s interest rate hikes on economic growth — on consumer incomes and spending, as well as on corporate margins and earnings, and accordingly, stock prices. The extent of the impact will depend on the product (goods or services) and demand elasticity and, critically, each company’s pricing power.
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We believe that US corporate earnings expectations — and margins that remain near historical highs — would have to be pared back over the course of the year. Given that valuations are still fairly high, even after last year’s decline, we are very cautious on the outlook for stocks, at least in the next few months. There are some that foresee prices retesting last year’s lows.
Historically, bonds perform better in the early stages of recessions. This is why we have recently switched a significant portion of our portfolio money into safe long-term sovereign bonds. That said, we will continue to monitor and reassess our position as more data becomes available. In particular, the big question is whether inflation has peaked and, if so, how long before it falls back to central banks’ target levels. And if not, how much higher it will rise and sustain at these high levels, and how many more interest rate increases are required to slow demand, as well as the inevitable repercussions? Will the Fed overshoot and cause a global recession or worse, undershoot, which will eventually lead to stagflation (as it did in the 1970s).
Plus, there are many known unknowns, in other words, the unpredictable, that could worsen the situation.
For starters, will there be a Covid-19 resurgence, especially with China’s reopening and the virus raging through its massive 1.4 billion population? We had recently pared back our exposure to Chinese stocks for the Global Portfolio. While we remain confident they will outperform over the longer term, there are significant uncertainties in the short term. Right now, there is very little data on how the pandemic is unfolding in the country after the government abandoned its zero-Covid strategy, and the impact on consumers and growth. There are supply disruptions from China in the short term. And beyond this, a lot of supply chain shifts as the result of the pandemic.
There will be continuing fallout from the Russia-Ukraine war, the US-China “chip war” and all its geopolitical repercussions as well as consequences from the weaponisation of the US dollar and oil.
The Fed’s aggressive interest rate hikes are creating a lot of pain for the rest of the world, by either leading to depreciation of their currencies — and therefore, importing and causing domestic inflation — and/or forcing other central banks to follow suit with higher interest rates too, resulting in more economic hardship. The International Monetary Fund (IMF) expects one third of the world’s economy to be in recession this year. And for those that manage to skirt recession, it would still feel like one to the majority of their people.
Europe is on the verge of recession and real wage growth has turned negative (due to high inflation). Consumption is falling everywhere due to higher prices, falls in real incomes and savings, ageing populations and so on. Vietnam’s stock market fell 33% in 2022, on expectations of weaker economic growth — with downbeat prospects for exports as the global economy slows — amid rising costs, including borrowings costs (see Charts 2 to 5). We will explore these topics in greater detail in future articles.
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All of the above uncertainties will make 2023 an “exciting” year for investors. We could see huge gains, or huge losses. Frankly, no one really knows what will happen. As the year progresses, we will gain better clarity. In the meantime, our strategy is one of balance — to generate positive returns but also to protect against unpredictable negative consequences.
We will round off this article by circling back to the subject of risk-adjusted returns. We use the weighted average beta of our portfolio holdings to derive the risks for both the Global and Malaysian portfolios. We lowered the Global Portfolio beta to less than 0.2, given the prevailing heightened uncertainties, through the very low-risk nature of our substantial bond holdings. (The portfolio’s risk-adjusted returns are far higher than the simple headline total returns because those returns were achieved with lower-than-market average risks.) But we also seek outsized returns by investing in emerging countries, specifically into Grab and GoTo Gojek. Their stock prices have tanked and, we think, are at or near bottom — thus, the risk-reward proposition from hereon is attractive. More importantly, we believe that both companies have enough cash to ride out the current environment and their business models are credible.
The Global Portfolio gained 2.4% for the week ended Jan 4, better than the benchmark MSCI World Net Return Index’s 1.9% advance. This is despite a weighted average portfolio beta of only 0.2. In other words, the Global Portfolio’s risk-adjusted returns for the week is theoretically 12%. All holdings in our portfolio ended higher, save for Global X China Electric Vehicle and Battery ETF, which was down 1.6%. The top gainers were Grab Holdings (+11.1%), GoTo Gojek Tokopedia (+7.1%) and iShares 20+ Year Treasury Bond ETF (+3.3%). Last week’s gains lifted total portfolio returns since inception to 25.2%, though we are still trailing the benchmark index’s 35.9% returns over the same period.
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/ or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
