2022 has been an exhilarating year for me, having witnessed some memorable events throughout the year. The lifting of COVID-19 restrictions and the reopening of international borders have allowed me to travel on a long-awaited holiday to Europe and also attend mega-conferences such as SuperReturn Asia where I met a lot of industry friends at. On the flip side, we have also encountered challenges during the year such as the Russia-Ukraine War, the stock market sell-off, and rising costs of living. As 2022 draws to a close, I will recap some of the trends which defined financial markets this year as well as offer my outlook for what is in store next year.
2022: An unremarkable year for equities
As I'm sure many of you are familiar with by now, the performance of US equities, which I mostly invest in is not very remarkable. The tech sector, which enjoyed a strong bull run before the 2022 selloff was among the sectors hardest hit by rising interest rates, in an attempt by the Fed to pump the brakes on red-hot inflation. Other sectors such as Financials and Retail were not spared the bloodshed as investors feared that the Fed's QT measures would lead to a recession in the US economy. On the contrary, Energy and Healthcare were the top-performing sectors due to the global energy shortage and rising costs of living.
As someone who just started investing 3 years ago, this rotation to value stocks and commodities caught me off guard as I had never seen such a radical shift in monetary policy and geopolitical relationships before. Many of my investments in growth stocks underperformed the market as they tend to fare the worse in a rising interest rate environment.
Investing in 2023
So after the market sell-off, I'm sure the question on every investor's mind is how will the market perform in 2023? Unfortunately, I am unable to answer this question as I cannot predict the future and the outcome for equities. However, what I can do is offer my views on macroeconomics and how businesses are likely to perform in the current situation.
Interest rates and the Fed
Higher interest rates have been the main catalyst for the market sell-off, leading to a correction in valuation multiples. Traders will continue to monitor CPI data for signs that inflation is easing and hope that the Fed will hike rates less aggressively in the near future. Currently, the Fed Funds Rate stands at 4.25-4.50%, while the latest CPI reading for November was 7.1%. This highlights that the Fed still has to hike interest rates by a couple of percentage points to achieve breakeven inflation. This leaves the Fed with 2 choices: either it continues raising rates and possibly risk a severe recession to the US economy, or abandon its hawkish stance and let inflation settle at a rate higher than its terminal target of 2%. My guess is that the Fed would by all means avoid the first outcome, settling for a less hawkish stance to prevent an all-out economic fallout. This means that the US economy is likely to head into a period of stagflation like the 1970s, where inflation remains persistent and real economic growth remains sluggish. In this type of environment, value stocks with low multiples and high earnings yield tend to perform the best due to the greater certainty of cash flows they provide. In the next section, I will share my top 3 investing themes, which I think will outperform in the next decade.
Industrial metals/Commodities
Underinvestment in mining over the past decade means that is a short-medium-term shortage in the supply of industrial metals. Industrial expansion in new industries and supply chain disruptions means that there is a tightness in supply across the board.
Underinvestment always precedes the next commodity cycle and the chart below shows that capital investments in major integrated oil and gas companies declined by 52% between 2013 and 2020. Capital expenditure in the copper industry declined by 44% between 2012 and 2020.
The only thing that can stimulate investment in these sectors is an increase in the price. If even half of the expected demand comes through, then supply will prove to be insufficient, which will push prices higher and stimulate investment.
On the other hand, the energy transition is set to accelerate demand sharply in the coming years as the world starts the switch to EVs and more renewable energy sources. The chart below shows the expected increase in demand for various metals use in lithium-ion batteries that will be required as part of the switch.
To capitalize on this structural growth trend, I have invested in mining companies $Vale SA(VALE)$ and $BHP GROUP LTD(BHP.AU)$ , planning to increase my exposure if their stock prices fall even lower.
Semiconductors
Semiconductors fared poorly in 2022, as valuations finally caught up with fundamentals and cyclical weakness meant that many semiconductor stocks suffered heavy drawdowns in 2022. Despite this short-term weakness, I believe that the semiconductor industry is poised to rebound over the next few years as they become an integral portion of the US infrastructure and economy. Secular growth in the automotive, data storage, and wireless industries will continue to drive demand for semiconductors, which will grow into a $1 Trillion market by 2030.
Government support will catalyze the boom of the industry. In July 2022, Congress passed the CHIPS Act of 2022 to strengthen domestic semiconductor manufacturing, design, and research, fortify the economy and national security, and reinforce America’s chip supply chains.
Using (Joel Greenblatt's) Magic Formula Stock Screener, UMC, QCOM, and LRCX are the highest-quality stocks with the cheapest valuation. Since I am more familiar with $Qualcomm(QCOM)$ and have invested in the company before in the past, it is my favored investment option. Moreover, it has one of the largest market caps in the industry and is a distinguished player in the industry.
Gold
Gold is my last pick for 2023 and a more defensive asset class should more volatility emerge in the markets. Gold is traditionally not only a hedge against volatility but also against inflation. As I have mentioned earlier, inflation levels are at their highest since the 1980s are likely to remain elevated. Since Russia's invasion of Ukraine earlier this year, geopolitical tensions have also flared up globally. The Geopolitical Risk Index has spiked to its highest level since 2001, reflecting the rise in geopolitical risk but also a profound paradigm shift in security policies for Europe and the rest of the world following the invasion of Ukraine. Therefore, in order to protect my portfolio, I have chosen to invest in Gold, which is a more defensive asset class during this period of volatility.
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