Dear friends,
We hope you’ve had a chance to spend some time with friends and family over the holidays.
As we begin 2023, many investors are looking back at 2022 as a year they are more than happy to see come to a close. 2022 broke a multi-year streak of positive returns for equity markets with broad indices finishing in firmly negative territory. Speculative growth stocks were hit hardest as momentum investors reversed course and sold many high-flying tech and recent IPO companies. The S&P 500 finished the year down nearly 20% while the tech-heavy Nasdaq Composite was down almost 33%. International stocks didn’t fare much better as the MSCI World Ex-US Index was down nearly 17%. And the bond market, typically a safe haven during stock market selloffs, had one of its worst years on record as the Bloomberg Aggregate US Bond Index was down approximately 13%.
The immediate cause for this across-the-board drop is the trajectory of interest rates, as the world confronts inflation levels not seen in decades. US rates started 2022 at nearly zero and ended the year at 4.5%, a remarkable pace of increases in a very short time period. Several other central banks also raised rates in an effort to rein in inflationary pressures. Acting belatedly, but with determination, central banks have taken away the easy money punch bowl put in place in the aftermath of the Great Financial Crisis, ending one of the longest bull market rallies in history.
Last year, we wrote about the risk in speculative assets and how many were trading at unsustainable valuations, appearing vulnerable to a market correction. The rapid rise in interest rates created an environment ripe for mean-reversion as investors bailed on these assets almost as quickly as they had bid them up. The ARK Innovation ETF (ARKK), a much followed barometer for speculative growth stocks, was down nearly 67% in 2022. Cryptocurrencies, rocked by several high-profile scandals and bankruptcies (FTX, Block-Fi, Voyager and Celsius) also saw steep losses. The Bitwise 10 Crypto Index (BITW – a fund comprising the 10 largest cryptocurrencies) fell over 68%. SPACs (special purpose acquisition companies) – quasi IPO companies taken public via mergers that had become popular in recent years – were also clobbered. The AXS De-SPAC ETF (DSPC) was down over 73%.
So what did well in 2022? Despite the broad carnage, there were a few bright spots. Defensive sectors did ok, with healthcare and consumer staples down slightly, while utilities were up slightly. Rising energy prices boosted energy stocks and commodities, with both asset classes posting their strongest returns in years. Rising interest rates benefitted floating rate bonds, money markets, and cash. The USD, riding the wave of higher interest rates, was up nearly 8%, its best return since 2015. Gold and silver also held up well, posting slightly positive returns.
And while investors are hoping 2023 brings stability to markets, the last two weeks have reminded us that several non-economic factors have the potential to create further turmoil. The Chinese government suddenly reversed its policy on Covid isolation, leading to a sharp increase in the number of cases. This has placed stresses on the Chinese health care system that are similar to those experienced in the US in 2020 and 2021. It has also impacted several industries within China, where a large number of workers are absent. The re-opening of the Chinese economy will also likely put renewed pressure on commodity prices, which only in
recent months had started to fall. The recent US midterm election has left the House of Representatives in a very delicate balance. The possibility that a financial crisis might originate with action or inaction in the House of Representatives is distinctly higher than it was prior to this election (debt ceiling negotiations are already set to be a battleground). The political situation in several South American countries is quite tenuous, with Peru and Brazil in the headlines. Both countries are major producers of raw materials for industry and agriculture. The Ukraine war enters its second year without a clear path towards resolution. The potential for negative exogenous shocks to the global economy are higher than usual.
That has driven the World Bank to reduce its global growth forecast to below 2%, one of the lowest projections since the 1990’s. Most larger US-listed companies operate globally, and will be impacted by this slowdown in global growth. We have already begun to see businesses focus on cost reduction in a form that we haven’t seen for several years. While times were good and order books were brimming, weaker business models could limp along. We expect 2023 will be a year of reckoning for aging or obsolete product lines, with corresponding impacts on revenues and earnings, as well as an uptick in bankruptcy filings.
We expect the US Federal Reserve to continue its tight monetary policy through the middle of this year, albeit at a slower and more guarded pace. We expect rates to rise another 50-100 basis points, depending on inflation data. The impact of the past raises has not yet been felt by all enterprises, but it will reverberate through the entire economy over the coming year. Higher than expected rates will continue to place a drag on businesses for 2023, and we expect to see a visible impact on earnings, which have thus far been remarkably stable. This has the potential to lead to more selling of risk assets. That said, if we see inflation tamed and the Fed pause or reverse course on their interest rate policy, it’s likely markets will rally. It remains to be seen whether this rally would be short-lived or a sustained change of course for markets.
We continue to advise cautious allocations to risk assets as part of balanced portfolios. We have begun to see more reasonable valuations in certain sectors, notably technology. International and emerging market stocks with strong balance sheets are starting to look more compelling for long term investors, especially if we see weakening of the USD. After last year’s route, entry points for high quality bonds of short and intermediate duration look good. We believe gold and silver remain important components of a diversified portfolio in the current environment.
In general, though, froth and speculation remain in several sectors, and we aim to be selective in our investments, focusing on quality businesses that can weather an economic downturn and have long term potential for sustainable growth.
Let us know if you would like to discuss any of the above in more detail.
Best,
Louis and Subir

The foregoing contents reflect the opinions of Washington Square Capital Management and are subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or constructed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. 

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