Here, we take a look at some of the major factors that combined to drive stocks and bonds lower in what turned out to be a turbulent year for markets.
Rising inflation and central bank responses arguably provided the biggest impact on financial markets in 2022. Supply chain disruptions caused by the COVID-19 pandemic and the impact of the war in Ukraine on global commodity prices combined to drive inflation sharply higher. This sharp increase caught central banks by surprise, forcing officials to aggressively raise interest rates despite just weeks and months earlier suggesting rate rises would be low and slow. Higher interest rates make the cost of borrowing money more expensive, which has a negative effect on both company profits and consumer spending.
In February, Russia invaded neighbouring Ukraine; a move which was widely condemned by the global community. In response, the West, led by the U.S., the European Union and the UK, imposed a raft of economic sanctions designed to isolate Russia from the rest of the global economy. Sanctions, however, would prove to be a double-edged sword as the subsequent disruption to global energy and commodity markets drove up prices for oil, wheat and gas and added to already-high inflationary pressures. The conflict also exposed Europe’s heavy reliance on Russian gas. Unfortunately, with no end to the war in sight, the conflict will remain a source of horror from a humanitarian point of view as well as a risk for markets in 2023.
China is a major manufacturing hub and a massive consumer of commodities, so any slowdown in Chinese economic growth has a knock-on effect on the rest of the world. Growth in China slowed to just 2.9% in 2022; well below the 5.5% target that Beijing set at the beginning of the year and highlighting the impact of the country’s strict COVID-zero policy on economic activity. Encouragingly, Beijing announced in December its intention to begin relaxing restrictions, which has helped fuel a strong rally in Chinese (and global) stocks. However, news of Beijing’s policy shift was tempered by concerns China’s ‘reopening’ could add to global inflationary pressures and potentially drive interest rates even higher.
Technology companies were amongst the biggest winners throughout the COVID-19 pandemic, however rising interest rates saw tech stocks fall sharply in 2022. This is because many technology companies are valued based on future profits, so as interest rates rise, the present value of those future profits falls. The tech-heavy NASDAQ Composite Index finished the year 33.1% lower, giving back all of the previous year’s gains and then some. This compares to much lower declines in the broader, less tech-heavy, stock indices like the Dow Jones and the S&P 500. Fortunately, easing inflation and a recent shift by some central banks toward smaller rate hikes have contributed to a positive start for technology stocks in 2023.