Looking back on a year of multiple crises.
“The basic rule of a crisis is that you don’t come out of it the same. If you get through it, you come out better or worse, but not the same.” This observation by Pope Francis has interesting implications for all of us but particularly for UK equity investors as 2022 has been the year of crises.
European war, energy-price spikes, inflation, rising interest rates, sterling weakness, looming recession and political disarray, as well as the longer-duration issue of climate change, have featured throughout 2022. Crises bring about change, and in 2022 the domino effects of these crises have been far-reaching. They have not only affected investment strategies and returns but have also challenged the investment philosophies themselves: active versus passive, conventional versus sustainable, growth versus value.
The most notable event in 2022 was unquestionably Russia’s invasion of Ukraine. The disruption of energy and food supplies, and the implications for energy prices and for defence spending created a negative impact wave leading to higher inflation, higher interest rates, lower economic growth and, consequently, lower equity prices. Sustainability was put on the back foot, with a general backing off of hawkishness on carbon emissions in favour of energy security, and a more positive assessment of the moral dilemmas around investing in defence.
In a potentially linked outcome, COP27 made no real progress on reducing carbon emissions. The war in Ukraine also put pressure on governments as they sought to mitigate the impact on their constituents. The UK did not fare well in this regard. 2022 has been the year of three prime ministers. Governance issues eliminated the first, economic incompetence the second, while the third, post the brief panic on bond yields and mortgage rates, has returned to defensive fiscal orthodoxy.
From a UK equity perspective, the investment impact of all this change has been substantial. Stocks negatively sensitive to higher interest rates, notably growth stocks, underperformed. The weak performance of the domestic economy alongside weak sterling hit the FTSE 250, while the FTSE 100 offered more resilience given its global tilt and its exposure to ‘invasion winners’ such as oils and mining, as well as financials which benefited from higher rates. In terms of investment styles, value (often ‘old economy’ – defence, tobacco, oil) outperformed growth, while conventional outperformed sustainable for similar reasons. Passive generally outperformed active, even though one could have assumed passive funds, which are commonly algorithms of the past, may have struggled with the extent of disruption. However, UK active investment managers’ continued bias towards growth and mid-cap stocks has largely proved costly.
In conclusion, it is worth noting that, despite everything, the FTSE 100 has remained almost flat in 2022. This is perhaps because the starting point, post Brexit and the pandemic, was already depressed. As we look towards 2023, the low equity valuations reflected in the index continue to suggest a gloomy outlook. However, outcomes are difficult to predict as the key crises of Ukraine and the threat of recession can still play out in different ways.
Meanwhile, reassessment of portfolio styles is likely to continue as negative investment performance challenges established trends towards growth and sustainability investing. Crises do tend to generate change and, consequently, change the perceptions of investors, although as active managers will attest, judging that change is not always easy. The burden of potential for investors to capitalise on this change remains as they seek to deliver positive returns versus the passive competition. Most will be hoping that 2023 is a less interesting year.
THIS ARTICLE FIRST APPEARED IN FT ADVISER
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