“There are decades where nothing happens, and years when decades happen.”

2022 was indeed one of those years. In February, Russia’s amassing of troops on Ukraine’s border quickly erupted in an armed conflict that is still ongoing. This caused oil and gas prices to increase, stoking already hot inflation from COVID-induced supply bottlenecks. Headline inflation surged to 40-year high in developed markets, which forced global central banks to tighten rates in an extremely aggressive manner. Twelve months ago, the market expected policy rates to rise to 1% by year-end. They are four times as much now, and further hikes are in store.

All this sparked a large, synchronous selloff in bonds and stocks: global stocks ended the year down 18%, while bonds fell 16%.

We have now entered a different phase, where markets are not as concerned about runaway inflation, but the consequences of tightening on the real economy. Inflation will eventually fall, but not fast enough for the Fed to blink before the economy buckles. Downside surprises in inflation will be the outcome of a recession, not a leading indicator to avoid it.

Tighter financial conditions and slower growth are an explosive mix that may create accidents. In 2022, equities and bonds suffered substantial mark to market losses.

Our focus on strong businesses, balance sheet strength, and healthy free cash flows are pillars that will help us avoid such permanent losses while we wait for the inevitable recovery. Markets under stress always end up creating value for long-term investors.

An example of this is in the shorter end of the government/IG space: a year ago, the short end was pretty much yielding nothing, whereas now, short yields are higher than long ones. Indeed, the pick-up in rates has opened up a tremendous opportunity for long-term investors to lock in the best levels of yield in more than 10 years.

To read the full AndPapers Q1 2023 click here

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