How will investment assets be priced in another year?

2022 was a year to forget for most investors, with almost every major listed asset class posting negative returns.

When it came to investment assets, all manner of bad records were broken. It was one of the rare times in history when both defensive assets, such as bonds, and growth assets such as shares, have fallen in value. This meant the generic 60/40 portfolio (comparable to many KiwiSaver Scheme growth or balanced funds) has probably had its worst inflation-adjusted year of performance since the great depression of nearly 100 years ago!

Even the New Zealand residential property market was hit.

Before we look at what this means moving forwards, let’s unpack what drove such poor investment outcomes.

Investments: The Background

This forgettable annual performance was rooted in the prior couple of years, when we had unprecedented worldwide money creation (mainly in the form of money-printing) in 2020 and 2021. At the time, most financial experts thought this was an appropriate response to stymie the impacts of economic damage caused by lockdowns intended to stop the spread of a virus.

It was appropriate, until it wasn’t.

Rather than be an antidote to economic pain, this response just made the inevitable pain even worse. Back in 2020 and 2021, this generous fiscal support contributed to an increase in the demand for consumption goods; we saw massive shifts in consumer behaviour in most western countries, including New Zealand. With much of the economy out of action, limited ways for people (consumers) to travel or spend, and plenty of handouts fleshing out household bank balances, spending on selected goods and services started to lift off. A ‘false economy’ was created with so many employees being unproductive - i.e., they weren’t adding any value to the real world - though were still being paid to sit at home. The values of many investment assets significantly lifted. Soon, mania gripped some investments, and based upon fear of missing out (“FOMO”), amateur money piled into meme stocks, cryptocurrencies, and digital artwork (including US$69 million for this jpeg file).

During this time, it also became clear production didn’t adjust quickly enough to meet the sharp increase in demand. This, along with national lockdowns, challenged supply chains globally. With this imbalance between supply and demand, it was only a matter of time before inflation hit. Which it did.

Enter the Villain, Inflation

Then, when New Zealand’s inflation was already at 5.9 percent (the highest in 30 years!) and trending up, President Putin started the largest conflict in Europe since World War Two. This drive up the price of oil, gas, and wheat. These additional costs were simply passed on to consumers with increased prices for petrol, flights, food, and a range of other things. This caused inflation figures to spike to even higher levels.

To fight inflation, central banks the world over have been hiking interest rates, causing even more pain for consumers and for businesses.

Investment markets do not like uncertainty and with all these developments taking place all at once, it caused the value of investments around the world to fall.

Perhaps the most surprising thing about all the inflation and economic disruption of last year was that it wasn’t worse, all-things considered!

What Next?

The rebound in investment valuations over the last month or so has provided investors with some relief, but it’s too early to be confident that we have seen the worst.

Do Lower Values Mean Better Returns?

Losses are no fun, but lower valuations mean higher income is usually paid by the investment asset as a percentage of its value (be it a house, bond, or share of ownership in a company). This can be great news for new investors. Let’s unpack this with a real estate example:

A residential investment property was previously valued at $1 million and is now valued at $900,000. The house has a tenant paying $40,000 per year (that’s about $770 per week). Assuming the rent is unchanged, i.e., the rent did not fall with the property value, the previous gross yield (total income) on the property was 4%. But now, as the value of the asset (the property) is lower, the gross yield has risen to 4.4%.

We don’t pretend to know what the rest of 2023 will bring, but every time we’ve ever had bad times in the past, they turned out to be wonderful opportunities for long-term investors. There are no guarantees, but things should be better for investors in the future if you have enough patience and perspective.

The main issue for 2023 is whether inflation pressures ease sufficiently to allow central banks to step away from rate hikes and potentially begin easing. We expect inflation will be on a downward trend as global demand slows. This should allow central banks to eventually change direction and may set the scene for the next economic upswing. Markets and economies move in cycles. There is no certainty that we have passed the worst of market conditions, but the contours of the next upswing for investments are visible on the horizon.

Markets, of course, are forward looking and usually price in bad economic outcomes ahead of time.

Although it’s unpleasant when markets decline, it’s worth remembering that they do tend to go up over the longer term. In fact, the most common share market measure, the S&P 500 Index, has risen 74% of the time since 1926. Those are pretty good odds.

The Bottom Line: Investments, the Future, and You

In the words of famous boxing character Rocky Balboa:

“… it ain't about how hard you hit. It's about how hard you can get hit and keep moving forward. How much you can take and keep moving forward.”

Beaten-down investors of 2022 have little choice other than sell all investments and stuff the proceeds under the mattress, or take on the Rocky mindset, and keep pushing forward into 2023!

If you would like to discuss anything above as it relates to you, including your current or intended investments, it would be our pleasure to assist you: simply book a complimentary initial consultation.