2022 FINANCIAL FRONTIERS REFLECTIONS & 2023 OUTLOOK

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1.  Goodbye 2022. Thank you for coming to an end. We bid farewell to you with a sense of gratification that we had made it through another year. A dramatic 2022 indeed. Despite the challenges and hardships that this year brought, we survived.   

2.  It is hard not to remember 2022. The Federal Reserve raised interest rates 7 times within a year, a total increment of 4.25%. Marking the first time such action Fed had taken since the Paul Volcker era. This is also a year of great losses. We said goodbye to many amazing mankind who have left an indelible mark on the world. From influential leaders to beloved cultural and sports icons, the passing of Queen Elizabeth II at the age of 96, as well as the shocking assassinations of Former Prime Minister Shinzo Abe, the deaths of Former Soviet leader Mikhail Gorbachev and Former Chinese leader Jiang Zemin. The world also mourned the loss of Brazilian football icon Pele, who once paid tribute and said to Maradona, “One day, I hope, we will play football together in heaven”. Their contributions and legacies will be forever remembered and celebrated in our hearts.  

3. How can we forget 2022? Within a year, the UK experienced three prime ministers, from Boris Johnson to Liz Truss to Rishi Sunak. Covid-19 continues to have a significant impact on global health, with a total of 6 million cases recorded in March. The Ukrainian-Russian War that began on February 24 has led to an energy crisis, food shortages, and rising prices for oil and other commodities, as well as concerns about high inflation and monetary tightening by central banks around the world to combat inflation and decrease the rate of economic expansion. Other headlines of the year that have negatively affected global economic conditions, include the rise of the US dollar and the decline of the Japanese yen, the UK debt crisis, Sri Lanka's bankruptcy announcement in July, and China's property crisis in October. These events have made 2022 an unforgettable year in history.  

4. Capital markets have struggled with major asset classes experiencing the steepest declines in stocks and bonds since 1871. The simultaneous sell-off of stocks and bonds was unusual. It defied conventional understanding of financial markets and challenged fundamental principles that we have come to rely upon. Despite their efforts to hedge against market downturns, asset management firms are still significantly impacted by negative market conditions. Even well-planned and executed strategies can fail by unexpected market movements. On average, global asset managers lost about 25% of their books in 2022.  

5. The tech sector faced great challenges this year. Some of the most well-known tech giants and market’s darlings, known collectively as the FAANGs (Facebook, Amazon, Apple, Netflix, and Google), have lost a staggering $3.4 trillion in market value since the start of the year, with a single week seeing a drop of $1 trillion. In a sharp fall from grace, these companies, which had seemed untouchable in their dominance, have returned to earth. Again, it is a reminder to us that even successful companies can be vulnerable to negative macro events.  

6. Tech-heavy Nasdaq experienced a 33% decline year-to-date, making it the second-worst performing index of 2022 in the world, just ahead of Russia's MOEX at the bottom. Facebook (now Meta Platforms) dropped 65% YTD, resulting in a market capitalization drop of more than $230 billion, the largest wipeout in stock market history. Worth over $1 trillion last year, Meta is now worth around $318 billion. Other great contributors to the great fall include Tesla (-70% YTD), Nvidia (-52% YTD), Intel (-50% YTD), Amazon (-50% YTD), Google (-57% YTD), Microsoft (-28% YTD), Apple (-28% YTD), Sea Limited (-76% YTD), etc. 

7. It is noteworthy that Tesla and Meta were two of the worst-performing stocks of the year, with both experiencing a drop of almost 70% in their share price YTD. One of the possible reasons for this decline could be the indirect political involvement of their high-profile CEOs, Elon Musk and Mark Zuckerberg. By showing support for the Republicans, they may have inadvertently caused their businesses to suffer. Is conspiracy theory at play again? As a general rule of thumb, it's always a wise idea for big businesses to stay out of politics.  

8. Many people have long believed that tech is unbreakable, but this year has shown otherwise. The tech sector has experienced significant declines, yet some young investors and retailers continue to exhibit fear of missing out (FOMO) and trying to buy on dips. This raises the question: Why do we continue to have this FOMO mentality and resist acknowledging that we are in a recessionary situation? 

9. This year, the crypto world came crumbling down in so many ways, plagued by macroeconomic pressures, scandals, and meltdowns that wiped out fortunes overnight. The once-hopeful rallying phrase of "to the moon" has become a distant memory as scams and misallocation of capital seemed to dominate the year. Coming off the euphoric highs of the year before (fallen over 50% from their peak in 2021), the crypto market has experienced sell-offs and the implosions of notable projects such as Terra and Do Kwon's Luna in May. There have also been bankruptcy filings from crypto exchanges and lenders companies including Three Arrow Capital (Singapore), Celsius Network, and Voyager Digital, as well as the climactic downfall of the FTX exchange by SBF's "year-long fraud”. All these events and the subsequent fallouts produced ripple effects, which affected other players in the ecosystem and dampened confidence in the Crypto World. One commonality among these failing companies is being run by kids who are less than 35 years old.  The question is why these “young wizard kids” can smoke the expert investors/ institutions so easily including at least two famous sovereign funds? Greed never changes. 

10. The once-hot Special Purpose Acquisition Companies (SPACs) faced a significant cooling off in 2022, as concerns about fraud and speculation led to a decline in their popularity, and many companies cancelled their plans to go public through this route. Again, signing blank cheques is never in our investment philosophy.   

11. At FF, we predicted a bearish outlook for the market in 2022 (in fact we predicted too early, as early as in the late summer of 2021). However, when it came to downsizing our portfolios, our execution fell short. Upon reflection, we are very disappointed with ourselves for continuing to hold so many stocks as if we were still in a bull market. We recognized that many analysts on Wall Street have become accustomed to buying on dips during long bull markets and have become complacent, failing in their understanding of macroeconomic movements. Analysts often rely heavily on static spreadsheets provided by companies that gave limited insight. This is a confirmation bias. In contrast, our focus on macro and global perspectives salvaged us to safety this time.   

12. In the first half of the year, the market was still performing relatively well despite high inflation as monetary policy was still very accommodative at the start of the year. Fed was falling behind the curve in addressing it. The Fed had stayed dovish throughout 2021 as it viewed inflation as “transitory”. Equity markets sold off hard early in the year, but have remained range-bound since June once a recession had already been priced in. A strong rally from Mid-June to July erased much of the year’s losses. It was fuelled by signs that we could avoid recession. But the rally fizzled out in late August. 

13. In late August, Federal Reserve Chairman Jerome Powell gave a speech at Jackson Hole (State of Wyoming, near Yellowstone National Park) that shocked the world and disrupted optimistic sentiments about the market. At that point in time, many analysts had expected that interest rates had peaked and that the end of rate hikes was near. However, Powell's speech indicated otherwise, leading to a tremendous downturn in the market. Jerome Powell reminded markets at every opportunity that the Fed would “stay the course” and fight inflation “until the job was done.” The Fed’s actions led to recession worries throughout 2022. Despite these worries, the consumer remained resilient, investors did not take Fed’s warning seriously for most of the year and the recession has not yet materialized.   

14. Our investment strategy involved being on the short side of the market. Short is good and we stayed light in holding stocks. However, we were too aggressive in our approach in October and ended up caught in the market run-up from late October to mid-December. This resulted in a shortfall for us. Of course, we had our uneasy times for two months. The market has since given further confirmation that a recession is likely, and we are back to our playground safely. In December, Powell reiterated that we are still far from the ideal 2% target point for inflation. (Current December’s Consumer Price Index (CPI) is 7.1% YoY, and Core CPI is 6% YoY)  

15. This recession is expected to be particularly challenging, as many investors have become accustomed to buying on dips during the last decade of low-interest rates and high leverage. This FOMO behaviour has become the norm and pushes many investors to be on the long side. 

16. At the start of the year, big houses in Wall Street like JP Morgan, Goldman Sachs, Citigroup were confident that the S&P 500 would reach high levels around 5,000 points by the end of 2022. However, the index has dipped to around 3,800 by the end of the year, proving that these predictions and institutions cannot always be relied upon. How do you predict the S&P 500 index by the end of 2023, 2,800 or lower? It's been a wild ride trying to navigate this inflationary landscape and the looming threat of a global recession ahead, but we'll keep on truckin' and see what 2023 brings!   

17. Going into 2023, we envisioned the possible landscape for the next 365 days. We think that all the black swans and animals would be released from the zoo, and they will be a force to be reckoned with. This is in line with our expectations from the January 2022 outlook, in which we mentioned weather havoc would wreck ships and sink weak hands in the next 2 years.  

18. The situation was exacerbated by the Pinocchio Chief, mainly the Fed Chairman, Mr. Jerome Powell, and his partner in crime, the US Treasury Secretary, Ms. Janet Yellen. They ignore tell-tale signs of runaway inflation and blatantly spin tales of transitory increases in a bid to mask off the eyes of the public and institutions.   

19. Our keywords for 2023 would be “Navigating the Polycrisis”. We identified the three pillars of risk to be: (1) Inflation, (2) Recession, and (3) Financial Stability. We foresee aggressive Fed policies to control high inflation risks a severe recession and global financial instability, but a strong policy could also allow inflation expectations to embed. Looking back at the Volcker era, he raised rates to be above 20% and people living in that era had the idea of never being able to afford to house etched to their hearts resulting in a negative spiral.  

20. Our base case would be a recession in 2023. First in the EU, then the US (moderate cyclical). The magnitude is to be influenced by Fed policies, gas flows (think: Russian-Ukraine complications), and China’s recovery.   

21. To navigate this potentially prolonged recession, we need to examine our investment strategies critically. We see the coming recession will be severe. A multi-year event that will be difficult for various central banks to manage. We are not just looking at the indexes. We are talking about a global economic slowdown for multi-years. While some experts have suggested that the market will begin to recover in the second half of 2023 and improve further in 2024, we believe that this may not be the case.   

22. The damage caused by the pandemic turned into endemic, supply chain disruptions, the trade war, and the short-anticipated war becoming long as well as demographic factors such as an aging population and a tendency for people to work less due to government support, will contribute to ongoing challenges. Particularly, labour shortages and high labour costs are likely to persist for some time. It is also unlikely that service costs will decrease unless the US adopts a thrift-oriented economic policy similar to Japan's, which has resulted in zero or even deflationary conditions. In contrast, the western approach of encouraging spending with borrowed money has led to high inflation that is expected to continue for many years. These might potentially be leading to stagflation or runaway inflation.  

23. FF has identified at least two potential black swan events for this year. The first is the ongoing war in Europe, which shows no signs of slowing down despite ongoing efforts to negotiate a resolution. The recent visit of Ukrainian President Zelensky to the White House and US promises of increased military and financial aid and advanced weapons suggest that the conflict may escalate further. The presence of military leaders from the Soviet Union, China, and Iran also indicates that more countries may become involved in the conflict. The ongoing riots in Paris and the deepening divisions within Europe only add to the uncertainty and instability of the situation. Given the history of World Wars I and II beginning in Europe, it is not unreasonable to predict the possibility of a third World War kick-start in Europe.   

24. The second black swan event that we predict for the coming year is a potential rate hike by the Bank of Japan (BoJ). While much of the world has been focused on China's reopening, Japan has emerged as a source of concern for us in 2023. Japan's inflation rate has reached a 40-year high of 3.7%, which is a significant increase from its previous low level. This is concerning as the Japanese are trained to be frugal and not consume. In response, the Bank of Japan (BoJ) recently widened the allowed trading band for 10-year Japanese government bonds (JGBs) by 25 basis points, allowing them to trade between -50 bps and +50 bps. This move, is seen as a test of the market's reaction to potential future rate hikes by the BoJ.  

25. Japan has been selling a large amount of US government bonds. Furthermore, the global market has been borrowing yen to buy US assets. If the BoJ were to initiate a 25-bps rate hike in 2023, the global market would likely scramble to sell assets and return yen to Japan. This will lead to a decoupling of the financial leverage field. The capital market is so weak now, can the market stomach another new wave of sell-off?   

26. Given the above scenarios, FF will be positioning itself as a “Papa Bear” in the market. We are anticipating serious asset readjustment before a meaningful bull market can occur in the next cycle. Yes, we mean a serious asset redistribution must occur first, or else there is no meaningful upside for the next bull market. There will be more earnings compression. Earnings are not expected to be robust in 2023 either. Going forward, it will be back to basics, with bad news being treated as bad news instead of being manipulated and interpreted as good news.   

27. Structurally higher inflation from the energy transition continues to be a key driving factor in 2023 even as supply chain pressure eases. Baltic dry index already dropped significantly compared to peak-COVID levels and is also now manageable compared to pre-COVID.  

28. On currencies, the interest rate differential drove the USD ever higher. This further creates headwinds for countries dependent on trade, there are large external debt burdens and maintaining a currency peg. A strong USD also has varying effects on corporates and margins dependent on existing supplier/customer relationships and credit arrangements. 

29. The vulnerability is even higher in Emerging Markets Foreign Exchange (EMFX). EMFX has not depreciated in line with other major USD crosses, suggesting more downside is possible. Together with Fed Hawkishness, slowing global growth, and Chinese currency (Renminbi) weakness, this underlies our bearish bias on EMFX.  

30. China transition: Strict anti-COVID measures began easing in Dec’22. The most significant of all is China lifting quarantine requirements for international travelers come 8 Jan 2023. This shows the willingness of the Xi administration to bow to increasing public pressure and dissent from the people. However, we see a potential oriental black swan as well. There has been a massive spike in the number of cases in China as she releases the zero COVID policies. They have stopped reporting official numbers, but some academics estimates as high as 39 million cases daily which threaten to cripple its healthcare system and bring social activities to a standstill. There are also existing ongoing rumours that populations are being intentionally infected through the water supply for the area to gain herd immunity.  

31. Overall asset allocation would be defensively positioned; underweighting equities, overweighing USD (relatively safe haven currency due to interest rate differential), and overweighing cash. The higher terminal rate, stubborn inflation, and weak sentiment still support USD strength.   

32. We are cautious about global equities and are looking to invest in high-quality stocks that are best placed to weather market volatility. Highly selective with a strong focus on companies with strong balance sheets and funding positions. Among these are favourite consumer brands, mission-critical software services, and quality-assured healthcare companies that possess strong intangible assets which are generally difficult to recreate or duplicate by competitors. 

33. To wrap up, we consider that the broader market outlook is going downhill, and there is going to be a colossal reshuffling and redistribution of assets. The sea of the capital market remains rocky as we sail into 2023, however, we stay aligned to our True North and guiding principles and are immune to the market noises and lies put forward by the politicians. We continue to stand steadfast and scout out undiscovered alpha opportunities. Again, our advice is not to trust these “young wizard kids” who come out to raise funds from you. Instead, these kids just want to have fun.