An Arbitrary Grading of Our 12 Themes for 2022
One of our more popular reading materials for the 2021 year was our “12 Themes of 2022” piece that we published just prior to the Holiday Season. As we have been working very diligently on publishing our 12 themes of 2023, we thought it would be an interesting exercise to go back and look at the potential themes we identified and see how they turned out. With the benefit of hindsight, we will be giving each theme a grade (completely arbitrarily) based on the relevance and the accuracy of the theme with respect to what transpired over the past 12 months. Keep your eyes open for our 2023 themes which should be published over the next few weeks.
1. Favour Companies with Pricing Power
Inflation continued to dominate headlines for the majority of 2022 and while markets were difficult throughout the year, companies and industries that could not raise prices for their goods/services were hit very hard relative to those that could. This theme was illustrated by the Healthcare Sector (with its pricing power) outperforming the Consumer Discretionary Sector(no pricing power) by nearly 20% year to date as of this writing. By focusing on investing in businesses with pricing power, we sheltered investors from a lot of potential downside.
2. Don’t forget about Copper and Oil
This theme really looked good for the first half of the year and, due to that strength within commodities for those six months, which is why the grade is so high. As of November month end, commodities have been the best performing asset class in 2022 with the BCI ETF having outperformed the S&P500 throughout 2022 by 32%. A few marks are docked because all of this outperformance was felt in the first 6 months of the year. Commodities peaked as of June 8th and have underperformed the S&P500 by nearly 13% since.
3. Short Duration Bonds for the Win
Absolute home run with this prediction as 2022 was a lesson for bond investors about the potential downside in long duration assets. For the first time in over 40 years, yields went up and went up A LOT and if your bond portfolio was exposed to long duration bonds you most likely experienced losses that you have never seen within fixed income before. The most widely used ETF for long duration bonds (TLT-US) and as of this writing, it is down nearly 30% on the year. While unprecedented, the TLT has serious interest rate risk as it is shown with a duration of over 17 years, as opposed to our Kipling Strategic Income Fund that has a 2 year duration and has seen a return of -1.8% through the first 11 months of the year.
4. Capital is at Risk if you Hold to Maturity
Another dead accurate prediction when it came to bonds. This fall, we saw the US 10 year bond hit its highest yield since 2007 at 4.37%. This was preceded by a 3-year period from 2018-2021 where that same 10 year bond went from a high of 3.25% to a low of 0.52%. Essentially, nearly every bond that had been issued from 2018-2022 was trading at a premium to par and then that premium was erased to a point where many of those bonds began trading at a discount (below issue level or par).
5. Single Family Housing Strength Doesn’t Stop
Our worst prediction for 2022. So, where did we go wrong? Well, the thesis was driven around the fact that the fundamentals for housing were very strong. Structurally we had underbuilt new housing communities since the Financial Crisis until 2019. Mix in the underinvestment with the demographics of the Millennial generation beginning to reach average “first time home buyer age,” it suggested that the strength in housing would continue. However, we did not see interest rates going up nearly as much as they did, which tempered mortgage demand. US mortgage rates went from nearly 2% in 2021 to 7% at one point in the late summer, which caused mortgage applications to plummet. While wrong for 2022, the underlying fundamental argument is still holding true. November saw an increase in mortgage applications of nearly 13% from October as mortgage rates fell nearly 0.5%. Due to this bounce back in mortgage demand homebuilders have seen a recent bout of outperformance after seriously struggling through the first 6 months of the year.
6. Liquidity continues to dry up
While accurate on the fact that we continued to see liquidity dry up, we were only talking about 3 rate hikes throughout 2022. In hindsight this is almost laughable as November saw the Federal Reserve raise rates for the 13th, 14th and 15th time all at once. December appears as if we will see another two rate hikes bringing the total of rate hikes to 17 for 2022. Liquidity within the financial system dried up faster and more rapidly than we could have imagined.
7. Tail Risk Protection
While the argument for Tail-Risk protection was primarily revolving around the fact that, in our view, traditional fixed income instruments were not going to buffer investors’ portfolios in a potential down market (A+ on this), tail-risk protection didn’t help either. While painful at times, the bear market that we saw in 2022 was very orderly and the VIX (volatility or fear index) never spiked to levels that would see any kind of Tail-Risk Protection strategy buffer losses in portfolios.
8. Non-profitable Covid Beneficiaries Will Continue their Disappointment
The pain and suffering continued. While Goldman Sachs Non-Profitable Tech index saw a return of -38% in 2021, the first 11 months of 2022 we saw that downward trend continue with that same index seeing a return of -58%. Worse than the index, major 2020 winners such as Zoom, Peleton and Roku followed their lackluster 2021’s with returns of -59%, -67% and -74% in 2022. What is perhaps more interesting is that the pain felt in the unprofitable sector expanded to include a lot of the profitable tech businesses and punishment for any new project that wasn’t profitable right away experienced downwards pressure in their stock prices (looking at you META). Investors mindset about profitability and growth has done a complete 180 over the last 24 months.
9. T.I.N.A -> There is No Alternative
While true at the beginning of the year, and why we were so weary on the majority of fixed income, this acronym was no longer relevant by about June. With the central banks on a historic rate hiking cycle TINA has transformed into TARA (There Are Reasonable Alternatives). Interest rates in GICs, Money Market Funds, Corporate Bonds and Government Bonds have gotten to a point that is generating a positive real rate of return for the first time in nearly 15 years. Equity investors are going to need to have a higher hurdle rate to justify the risk associated within equity markets going forward.
10. Diversification beyond the Traditional Balanced Allocation is the Key
The traditional balanced 60/40 portfolio has had one of its worst calendar years on records as equity and fixed income became nearly perfectly correlated. A balanced portfolio made up of the MSCI World Index and the Canadian Aggregate Bond index would have seen a return of nearly –9% through the first 11 months of the year. Alternative assets and alternative strategies have buffered losses and done wonders for diversification within portfolios.
11. When it comes to Shorting, Fundamentals will Matter!
While possibly a very obvious theme, one must go back and think of the environment we were exiting at the end of 2021. Liquidity and support was the main theme and, as we had just experienced in 2020 and through the majority of 2021, stocks just went up. A rising tide lifts all boats and the least seaworthy rise the fastest. The reversal of liquidity that we saw in 2022 has reversed this phenomena and has led to a resurgence in fundamentals mattering.
12. Increased Participation in cryptocurrencies
While the direction of the price doesn’t suggest it, major cryptocurrencies did continue to see an increase in participation. Globally the number of exchange traded crypto products has increased nearly 70% in 2022 going from 111 products at the beginning of the year to 186 products by the end of September. Interestingly enough, it is not North America that is leading the way of growth in product, but global banking capital Switzerland. All of this adoption in the face of a 70%+ drawdown.
Overall Grade: A-
As Yogi Berra famously said “It’s tough to make predictions, especially about the future” but we will happily take our arbitrary honour roll grade of A-. It has been a wild ride, but 2022 has proven to be a year where a lot of investors should be going back to the drawing board and adjusting the way they view the world. To our clients that have entrusted us with their hard-earned wealth – thank you for that trust. Keep your eyes peeled for our 12 themes of 2023 piece coming up in the next few weeks.
*Cumberland and Cumberland Private Wealth refer to Cumberland Private Wealth Management Inc. (CPWM) and Cumberland Investment Counsel Inc. (CIC). NCM Asset Management Ltd. (NCM) is the Investment Fund Manager and CIC is the sub-advisor to the Kipling and NCM Funds. CIC is also the sub-advisor to certain CPWM investment mandates. This communication is for informational purposes only and is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon for providing such advice. Any comments, statements or opinions made herein are those of the author and do not necessarily reflect those of Cumberland Private Wealth Management Inc. (Cumberland) and are not endorsed by Cumberland. The communication may contain forward-looking statements which are not guarantees of future performance. Forward-looking statements involve inherent risk and uncertainties, so it is possible that predictions, forecasts, projections and other forward-looking statements will not be achieved. All opinions in forward-looking statements are subject to change without notice. Past performance does not guarantee future results. CPWM and CIC may engage in trading strategies or hold long or short positions in any of the securities discussed in this communication and may alter such trading strategies or unwind such positions at any time without notice or liability. CPWM, CIC and NCM are under the common ownership of Cumberland Partners Ltd. Please contact your Portfolio Manager and refer to the offering documents for additional information.