Morningstar - Q1 2023 - 42

Strategies
5 Things We Learned About Investing
in 2022
Morningstar indexes reveal lessons
about the unpredictability of markets
in a painful year.
LESSONS
Dan Lefkovitz
There's no shortage of pearls of wisdom in
the investing world. Any trader or broker could
reel off old saws like " Don't fight the Fed "
or " Buy the rumor, sell the news. " Rules of thumb
try to explain what moves markets, how assets
interact, and which investments best suit the
macro environment.
Much of this wisdom is flawed, however. The
forces that drive financial market behavior
are unpredictable, and relationships between
assets are fluid. Investment claims are often made
by those who have something to sell. What
can sound axiomatic often violates actual truisms
like " Past performance is no guarantee of future
results, " " The plural of anecdote is not data, "
and " The best company can be a bad investment
at the wrong price. "
Markets were vexing in 2022. Generationally
high inflation, a belated but aggressive monetary
policy response, and Russia's invasion of
Ukraine wreaked havoc on stocks, bonds, and
other assets. For investors, the year delivered
painful lessons that defied conventional wisdom.
Here are five things we learned from 2022.
Lesson 1: Sometimes Diversification Makes
You Pay for Lunch
Diversification has long been referred to as the
only free lunch in investing. But classic stock/bond
diversification did not work in 2022. Stubbornly
42
Morningstar Q1 2023
high inflation in most major markets, a string of
steep interest-rate hikes by central banks,
recessionary worries, and conflict in Europe took a
heavy toll on both major asset classes. The
Morningstar US Moderate Target Allocation Index,
which represents the traditional mix of 60%
stocks and 40% bonds, declined 15.3% in 2022.
Morningstar's range of multi-asset indexes
for investors in Australia, Canada, the eurozone,
Japan, New Zealand, and the United Kingdom
also suffered losses for the year thanks to the
synchronized swan dive for both equities and fixed
income, as represented by the Morningstar
Global Markets and the Morningstar Global Core
Bond indexes in EXHIBIT 1 .
Ballast is a popular metaphor for bonds. Fixed
income is supposed to be a boring but stable asset
class, capable of keeping a portfolio steady even
in the stormiest waters. This is exactly the role
fixed income played in the three most recent bear
markets for equities before 2022-at the onset of
the COVID-19 pandemic in the first quarter
of 2020, the global financial crisis of 2007-09, and
the dot-com bubble in 2000-02, when the crash
of technology, media, and telecom stocks
was followed by recession and 9/11. In each period,
the Morningstar Global Core Bond Index was
in positive territory when the Morningstar Global
Markets Index suffered heavy losses.
In retrospect, the 2022 fixed-income meltdown
looks obvious. Thanks to rock-bottom interest rates
in response to the pandemic, bond yields
were at historic lows in many markets. Then came
inflation and rate hikes. Yields soared and
prices sank. It should be noted that low
bond yields in the aftermath of the global financial
crisis did not presage disaster for fixed income,
despite many warnings of " bond bubbles "
and commentators writing off bonds as " returnfree
risks. " Raging inflation foreseen by
the doomsayers of the 2010s didn't materialize.
Perhaps the cries of wolf from those years
begat recent complacency?
What about other forms of diversification
in 2022? Gold, a millennia-old store of
value, did not serve that function. Neither did
cryptocurrency, supposedly a more modern
inflation hedge. Some alternative strategies, such
as trend-following, finally did well after
many years of languishing.
Among traditional stocks and bonds, energyrelated
equity investments were a real bright spot
in 2022. Morningstar indexes representing
upstream, midstream, and downstream nodes
of the energy value chain all saw heady
gains. The trouble is that many investors had given
up on their commodities-related investments
after years of poor returns and had little exposure.
The energy sector shrank from 11% of the
Morningstar Global Markets Index in 2011 to
just 3.5% at the end of 2021.
Where do investors go from here?
The good news from both an income and
total return perspective is that bond yields have
risen steeply in most major markets. The
Morningstar Global Core Bond Index, for example,
has seen its yield rise from 1.05% at the
start of 2022 to 3.3% at year's end. Niche
areas within fixed income offer juicier yields. The
Morningstar LSTA US Leveraged Loan Index,
for example, carried a 10% yield at the
end of 2022, while the Morningstar European
Leveraged Loan Index yielded 8.6%.
During years of low interest rates and depressed
bond yields, market watchers talked of TINA
(there is no alternative to equities). Fixed income
increasingly offers an alternative, which
may not be great for equities, but certainly gives
debtholders and income investors much
to celebrate.
Morningstar - Q1 2023

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