What should be the lesson to take away from 2022? Should investors not have known what was coming and go into cash or bought shares most likely to perform under the prevailing conditions? Or do we really understand what expectations were priced into securities?
Predicting future events is like planning to go on holiday. You only pack what you assume you will need or be anxious and cram too much. Similarly, forecasting relies on extrapolating future events on what is known, provided that other factors or circumstances remain the same— ever forgotten to pack sunscreen or it has rained on a summer holiday? This methodology has its merits, as things typically stay the same. When things deviate from the norm, this type of forecasting has significant shortfalls. The longer things remain the same, the higher the risk.
Future expectations cannot be the sole basis for investments. Consider investor sentiment. Security prices result from how investors react to events, based mainly on how they compare with expectations.
Macro events are complex and difficult to predict with unexpected variables. Did anyone pack the Ukrainian conflict into the 2022 suitcase? Similar uncertainty applies at the company level. A company's investment cycle will impact its earnings resulting in lower current versus higher future earnings. So how should one conclude what is being priced in by markets? Asset prices can infer expectations, but this data can only be an assumption.
Regarding security pricing, it is true that events are unpredictable and can be influenced by unforeseen factors. And this is the case for investors, too, as their reactions to the events can be capricious. Given the uncertainty, improving returns can be challenging by focusing on short-term goals. In times of volatility, like in 2022, one must refrain from being reactive. Emotional trading wastes time and takes away the opportunity to make successful trades.
What matters is how the value of your investments changes over a certain period and how it compares to your initial investment and goals. Every time investors trade, they expose themselves to being out of the market. Furthermore, when the trade is wrong, it will have a multiplier effect on losses. Trading often to capitalise on relative value assessments is based on extrapolation. Remember the sunscreen.
With goals and processes in mind, the principles of sound investing are straightforward. The basis of fundamental research over several years is the basis of a sound approach with moderate changes when needed. Better opportunities and not anxiety is the trigger for change. In October, investors were depressed. Where would they be now if they had sold positions?
2022 illustrated the importance of a correct risk posture balancing aggressiveness and defensiveness. Though each investor's risk profile is determined by their independent financial capacity, objectives, desires, ability to tolerate fluctuations in the market and personal risk tolerance, investors could have suffered heavily this year by over exposure to growth equities. Return potential is good, but increased return potential typically also means increased risk.
This year lay witness to a critical macroeconomic event. Arguably, since the global financial crisis of 2008, central banks pumped liquidity into markets with little inflationary consequences. 2022 saw witness to a "normalisation" of monetary policy, resulting in real yields and fixed income offering solid returns.
In the new year, there is a growing risk of recession. Coming back to the sunscreen analogy, we can pack this into our bag for 2023. The questions that arise are will this result in further market volatility, and will we be retesting the lows of 2022? What will be the central banks' reactions? Will this trigger a rate-cut cycle? What will happen to labour markets and household spending?
Inflation has shown signs of slowing, and there is the likelihood of further economic deterioration and increased unemployment. It is also safe to include the possibility of equities testing previous lows before we enjoy calmers waters. Hold on. We should pack our things into two bags instead of one. 2023 should see the increased benefit of an equity and fixed-income balanced portfolio.