2022 was a year of huge stories. Huge.
In technical advances, MRNA therapy got its first positive results with a cancer vaccine, we sustained nuclear fusion for one-billionth of a second, and the Webb telescope looked back in time 13 billion years. (It is not just the future that is bright. With the Webb telescope, so is the past.) And normal people are using AI as a catalyst for creativity. 2022 could become a marker for a new era.
In finance, interest rates have gone positive again. Put simply, money is no longer free. I see this as a setback. You experienced it as the worst year for your portfolio since 2008.
In 2008, the economy destroyed 3.5 million jobs. It is little wonder that the NASDAQ fell by 40% that year. By contrast, this year the economy created 4.5 million jobs. So why did the NASDAQ fall 33% this year? The simple answer is that real interest rates rose 2% during 2022, from a NEGATIVE one-third to a positive one and two-thirds percent. Negative rates make the future incredibly valuable; rather than discount future earnings, negative interest rates actually boost them. What does that mean? Startups, companies with high-risk, high-return products who are trying to create new markets see their valuations surge. But once those rates rise from negative to positive, the value of those speculative earnings plummets.
Prior to 2022, Fed Chair Powell had continued to stimulate the economy with low interest rates even when the unemployment rate was hitting historically low rates. Twice the unemployment rate has hit 3.5% in these 2020s, its lowest rate in about half a century. And rather than raise rates, Powell kept them low, continuing to buy securities as well (what you've heard referenced as QE). Why continue to stimulate the economy with unemployment rates so low? The economy continued to create jobs without inflation.
Last year, inflation hit. Hard. It peaked at 8.1%. Powell began raising rates and all those speculative stocks and exciting unicorns saw their values plummet as interest rates rose into positive territory.
The biggest question for me is simply this: will the extended period of negative real interest rates turn out to be an anomaly or will this period of positive real rates turn out to be (as I suspect it to be) a slight setback towards a new world of negative real interest rates? If it is the first and positive real rates are the new normal, you’re not getting a snap back in your portfolio. It will languish. If it is the latter, and real rates begin dropping again next year, your portfolio will start rising again, perhaps even dramatically.
The third big story is the struggle between autocracies and democracies. It was not a good year for autocracies. Xi pursued absurd COVID policies, dramatically shutting down the country in pursuit of 0-COVID. Putin pursued absurd military policies, invading Ukraine. Both leaders demonstrated one of the biggest flaws with autocracies: the ability to pursue stupid and dangerous policies without dissent. And both leaders created inflation that hurt developed nations. Russian oil prices spiked with the Ukrainian invasion, triggering broader inflation. China’s shutdown was a big part of why supply chains were snarled, another catalyst for price hikes. Dramatically illustrated by Trump’s love for Kim Jong-un and Putin and desire to abandon NATO, autocracies had gained in recent years, leading to a democratic recession. Biden’s election and the events of the last couple of years in Russia and China have seemed to stall the advance of autocracies. This has yet to resolve and could be even messier before it does. Still, this is good news because it suggests that the advance of autocracies has stalled, if not reversed.
Science advances that read like science fiction and a setback for the advance of autocracies is great news. However, a reversal of a bold financial experiment in negative real interest rates seems to me a setback in the transition into an economy that puts more value on the world a generation from now more than it does the world of today. All of these mark 2022 as a year of dramatic change that could ripple into the next generation.