Andrew Sheets: Lessons from Last Year

Discover what 2022, a historic year for markets, can teach investors as they navigate the new year.

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Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross Asset Strategist for Morgan Stanley. Along with my colleagues, bringing you a variety of perspectives, I'll be talking about trends across the global investment landscape and how we put those ideas together. It's Friday, January 6th at 2 p.m. in London.

For the year ahead, we think U.S. growth slows while China accelerates, inflation moderates and central banks pause their rate hikes while keeping policy restrictive enough to slow growth. We think that backdrop favors bonds over stocks, emerging over developed markets and international over U.S. equities.

But there'll be plenty of time to discuss those views and more in the coming weeks. Today, I wanted to take a step back and talk a little about the year that was. 2022 was historic and within these unusual swings are some important lessons for the year ahead.

First, for the avoidance of doubt, 2022 was not normal. It was likely the first year since at least the 1870s that both U.S. stocks and long-term bonds fell more than 10% in the same calendar year. We don't think that repeats and forecast small positive total returns for both U.S. stocks and bonds in the year ahead.

Second, it was a year that challenged some conventional wisdom about what counts as a risky part of one's portfolio. So-called defensive stocks—those in consumer staples, health care and utilities—outperformed significantly, which isn't a surprise given the poor market environment. But other things were more unusual. Small cap stocks and value stocks, which are often seen as riskier, actually outperformed. Financial equities were the second-best performing sector in Europe, Japan and emerging markets despite being seen as a riskier sector. And both the stock market and currencies of Mexico and Brazil, markets that are seen as high beta, gained in dollar terms despite the historically difficult market environment.

This is all a great reminder that the riskiness of an asset class is not set in stone. And it shows the importance of valuation. Small caps, value stocks and Mexico and Brazilian assets all entered 2022 with large historical valuation discounts, which may help explain why they were able to hold up so well. For this year, we think attractive relative valuation could mean international equities are actually less risky than U.S. equities, bucking some of the historical trends.

Finally, 2022 was a great year for the so called 'momentum factor.' Factor investing is the idea that you favor a certain characteristic over and over. So, for example, always buying assets that are cheaper, the 'value factor,' buying assets that pay you more, the 'carry factor,' or always buying assets that are doing better, the 'momentum factor.'

In 2022, buying what had been rising, both outright or relative to its peers, worked pretty well across assets despite the simplicity of this strategy. Our work has suggested that momentum has a lower return than these other factors but is often very helpful in more difficult market environments. It's a good reminder that it's not always best to be contrarian and sometimes going with the trend is a simple but effective strategy, especially in commodities and short-term interest rates.

2022 is in the record books. It was an unusual year but one that still provides some useful and important lessons for the year that lies ahead.

Happy New Year and thanks for listening. Subscribe to Thoughts on the Market on Apple Podcasts or wherever you listen and leave us to review. We'd love to hear from you.