2022: A Brief Review
It seems that every year is filled with numerous twists, turns and surprises.
This year is no exception, as 2022 is just days from giving way to 2023. The biggest surprise of 2022 to many was inflation, and it influenced many things during the year.
Investors and policymakers started 2022 with a great deal of optimism about the economy and markets. They expected inflation to quickly recede from the levels recorded late in 2021.
The 12-month change in the Consumer Price Index (CPI) at the start of 2022 was 7.53%. But the CPI didn’t peak until June, when it hit the highest level in more than 40 years. Other inflation measures also reached their highest levels in more than 40 years.
Another unexpected event was Russia’s invasion of Ukraine. The possibility there would be an invasion wasn’t on many people’s minds 12 months ago, but on Feb. 24 the military assault began.
The effects of the invasion were significant, and many continue. Stock markets initially plummeted. Prices surged for energy and other commodities. Russia was a major global supplier of energy, especially to Europe, and Ukraine was a major supplier of grains and some other goods and services.
Sanctions against Russia disrupted energy supplies, pushing prices higher. The effects of the invasion and Russian blockades disrupted Ukraine’s grain exports.
Commodity prices didn’t peak until early June, with energy prices having risen more than 50% from the end of 2021. Even after declining, many commodity indexes will close 2022 about 20% higher than they started the year.
Some effects of the invasion were short term. But the invasion led to many structural changes that will be long term. Perhaps the most important is the reordering of Europe’s energy market.
China also was a major factor in the global economy and markets, with COVID-19 being the dominating force.
China continued what it called dynamic zero-COVID policies. The policies required entire cities to be closed at the sign of any infections. Almost all business and personal activities would be suspended until government officials were satisfied there was no danger of infections spreading.
The shutdowns were unpredictable and greatly reduced production. They made global supply chain problems worse and exacerbated global inflation.
The shutdowns also substantially reduced China’s economic growth, which, in turn, slashed growth in many other countries.
Only after widespread public demonstrations did the government relax the COVID policies late in 2022. The immediate effects of the new policies might not be much better, because COVID apparently is spreading rapidly in a population that is largely unvaccinated.
COVID was not the only factor influencing change in China.
On his way to an unprecedented third term, President Xi Jingping made significant policy changes.
China now gives priority to ensuring the pre-eminence of the Communist Party, even if that means sacrificing some economic growth.
For example, private tutoring and education firms essentially were outlawed. Restrictions were placed on the size, growth and activities of firms, especially technology companies.
Jack Ma, the billionaire founder of the Alibaba Group, essentially had his companies taken from him and he disappeared from public life. Late in the year, Ma was reported to have been living in Tokyo for at least six months, interrupted by trips to the United States and Israel. He has led a quiet life as a modern art collector.
China also is wrestling with high debt levels. That excess has appeared in real estate investment and development, among others.
Many Chinese companies were delisted from U.S. stock exchanges or canceled plans to go public because of disagreements between U.S. and Chinese regulators about the amount of information the companies would release outside China. Regulators announced their disagreements were resolved late in 2022.
That regulatory dispute was only part of the escalating conflict between the United States and China about global dominance. Stocks of China-based companies fell most of the year, but a November rally trimmed the year’s losses to around 30%.
An important long-term effect of these events is Western companies are recreating their supply chains, so they are less dependent on China.
In May, the Fed finally became serious about containing inflation when it began increasing short-term interest rates by three-quarters of a point. By the end of 2022, the Fed increased rates by three quarters of a point four consecutive times. In December, the Fed increased rates another half a percentage point, bringing the effective federal funds rate to around 4.25% and short-term treasury bill rates to around 4.35%.
Interest rates increased at perhaps the fastest rate ever in 2022, and certainly the fastest rate since the days of Paul Volcker.
In addition, the Fed began draining liquidity from the economy by reducing its balance sheet. It sold assets that it purchased under the quantitative easing policy begun in 2009.
The tightening had an immediate effect on stock and bond prices. Though both rallied for much of November and December 2022, it was a rare year in which both stock and bond indexes declined by double-digit percentages.
It likely will be the worst year ever for treasury bonds and for the traditional portfolio that is invested 60% in stocks and 40% in bonds.
Because of lags in the effects of monetary policy changes, inflation stayed high well after the Fed began tightening. The November CPI, issued in December, reported a 12-month increase of 7.1%.
The more speculative asset markets were the first to feel the effects of tightening. Significant declines occurred in many of the former “unicorn” stocks that captured high stock valuations, despite having negative earnings and, in some cases, little or no revenue.
The meme stocks, and stocks of companies that benefited the most from the pandemic economy, also declined on orders of 70% or more.
Perhaps hardest hit were the digital currencies and related investments, which were declining before 2022. Bitcoin, for example, went from a high of almost $67,000 in November 2021 to less than $17,000 recently.
The collapse and bankruptcy of FTX would have happened at some point but probably was accelerated by the Fed’s tight monetary policy. Outright frauds and Ponzi schemes almost always are revealed when the central bank drains liquidity from the economy.
Most people, if they’d known at the start of the year that these events would occur, would have assumed the economy would be in a recession by the end of the year.
Housing, technology and some other interest-rate sensitive sectors retreated during the year.
But most of the economy, and especially the service sector, still was growing at year end. The excess demand generated by the expansionary monetary policy of 2020 and 2021 became self-sustaining.
At some point in 2023, the effects of tighter money will flow through the economy with their usual lags. The real issues are whether the decline in economic activity will be gradual or quick, and how much the economy will decline before inflation reaches a level that is acceptable to Fed leaders.
Corporate earnings will decline more than expected and reflected in recent stock prices. There is likely to be another significant negative move in the stock indexes before the Fed decides it’s time to ease monetary policy. Usually, bear markets don’t end until after the Fed begins to ease monetary policy.
It is still a good idea to be cautious with your investments. Interest rates will peak, probably in the first half of 2023. Until then, have a margin of safety in all your investments, be diversified, and have flexibility in your portfolio.
The Data
Personal income increased 0.4% in November, following a 0.7% jump in October.
Personal consumption expenditures (PCE) increased only 0.1% in November, but October’s increase in PCE was revised higher to 0.9%. Spending on services increased in November while spending on goods declined.
But after adjusting for inflation, PCE was flat in November.
The Fed’s preferred measure of inflation, the PCE Price Index, increased only 0.1% in November. That brought the 12-month rate of change to 5.5%, down from 6.1% in October.
The core PCE Price index, which excludes food and energy, increased 0.2% in November after rising 0.3% in October.
The 12-month change in the core PCE Price Index is down to 4.7% in November from 5.0% in October.
Durable goods orders declined 2.1% in November, the largest monthly decrease since April 2020.
The sharpest decline was in volatile transportation orders. After excluding transportation, orders increased 0.2%. Excluding both transportation and defense, which is considered a good measure of business investment, orders still increased 0.2% in November.
Housing starts declined in November for the third consecutive month, falling by 0.5% from October’s level. Single-family home starts declined by 4.1% in November while multi-family home starts increased by 4.8%.
Existing home sales fell 7.7% in November. That’s the 10th consecutive month of declines and brings the number of existing home sales to their lowest level since May 2020.
For the last 12 months, existing home sales declined 35.4%. That’s the biggest 12-month decline since November 2010, excluding the pandemic period.
The median price of existing homes sold increased 3.5% over 12 months to $370,700. Pending home sales declined by 4.0% in November. That’s the sixth consecutive monthly decline. Over 12 months, pending home sales declined 37.8%. That’s the largest decline since November 2021 and the 18th straight month the measure slid.
New home sales increased 5.8% in November, following an 8.2% increase in October. Economists were expecting a decline.
The median price of a new home sold in November was $471,200 while the average price was $543,600.
Home prices declined by 0.8% in October, according to the S&P Corelogic Case-Shiller Home Price Index, the fourth consecutive monthly dip.
Over 12 months, the Home Price Index increased 8.6%, which is down from 10.4% in September. October’s 12-month increase is the lowest since October 2020, and October is the sixth consecutive month the 12-month number declined.
The FHFA House Price Index increased 0.1% in October and 9.8% over 12 months.
The final Consumer Sentiment Index for December from the University of Michigan increased to 59.7 from the 59.1 recorded at mid-month and 56.8 at the end of November.
Inflationary expectations declined and expectations for the next six months improved. But assessments of current conditions fell.
The Kansas City Fed Manufacturing Index declined in December to negative 13 from negative 10 in November. The employment index component fell to its lowest level since 2020 and indicated flat employment for the month.
The Dallas Fed Manufacturing Index fell to negative 18.8 in December from negative 14.4 in November. That’s the eighth consecutive month the index was negative.
The Richmond Fed Manufacturing Index improved by five points in December to 1. That’s the highest reading since April.
The third estimate of gross domestic product (GDP) for the third quarter was that GDP increased at a 3.2% annualized rate. That compares to 2.9% in the second estimate. The main reasons for the change were higher estimated levels of consumer spending and nonresidential investment.
New unemployment claims increased by 2,000 to 216,000 in the latest week. Continuing claims decreased by 6,000 to 1.672 million.
The Markets
The S&P 500 rose 0.23% for the week ended with Tuesday’s close. The Dow Jones Industrial Average gained 1.22%. The Russell 2000 increased 0.17%. The All-Country World Index (excluding U.S. stocks) added 1.06%. Emerging market equities improved 1.35%.
Long-term treasuries lost 3.19% for the week. Investment-grade bonds fell 0.95%. Treasury Inflation-Protected Securities (TIPS) declined 0.69%. High-yield bonds retreated 0.55%.
In the currency arena, the U.S. dollar rose 0.32%.
Energy-based commodities increased 4.02%. Broader-based commodities rose 1.95%. Gold fell 0.32%.
Bob’s News & Updates
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