2022 was an unforgettable year, for all the wrong reasons, but one that could prove to be a major turning point. We look back over some of the critical issues.
We have just endured a notably eventful year by most measures and it is well worth revisiting, as traumatic as that may be. An apparent inflection point in the ‘Great Moderation’, it could signal major changes to the geopolitical order and the monetary orthodoxy. If that is right, then recognising the oscillating patterns could help both professionally and personally. Whilst this blog is for litigators, we hope others can benefit from it as well. This should not be considered financial advice, and individuals should take professional advice before making changes to their investment portfolio and financial arrangements.
Ukraine and the Putin’s invasion
Geopolitical tensions have been bubbling under the surface for nearly two decades. If the fall of the Berlin Wall ushered in Pax Americana (an era of US hegemony, as Niall Ferguson puts it), then the Great Financial Crisis of 2008 and the unsuccessful middle east wars would raise questions about its continued dominance.
The biggest threats would be from within, as populist movements from the Tea Party to MAGA would challenge the seven decade old globalist doctrine. The aftermath of the GFC was painful, and despite enormous central bank interventions to ease the financial discomfort, the 2010s witnessed a rise in populist politics across some of the most populous nations in the world, with Modi in India, Bolsonaro in Brazil, Duterte in Philippines, Erdogan in Turkey to name a few. Nationalism rose in Russia and China too. In Europe, the UK went through Brexit, Hungary, Greece and Italy all saw the successful rise of fringe parties.
With liberal democracies internally preoccupied, Vladimir Putin’s ambitions to re-establish Russia within a new multi-polar world were slowly being realised. Expeditions into Georgia and in 2014 into Ukraine went largely unchecked, emboldening the Russian autocrat further. Putin claimed these aggressions are in fact defensive in nature due NATO expansions, and whilst that could have some foundation within a strict security paradigm, within the modern framework of international law, and the rights of sovereign nations and people, it doesn’t really cut the mustard.
2022 witnessed the Putin’s first fully fledged invasion of a neighbouring country. Being major exporters of commodities, a Russia Ukraine conflict was always going to impact the markets through inflation in essential raw goods. In fact the real surprise was how muted the impact turned out to be.
A second surprise was the resolute defence of Ukraine by its citizens in the face of its seemingly dominant neighbour, and the coalescing effect that had on liberal democracies around the world. Ukrainians have endured various occupations by their powerful neighbours over the centuries, and most recently under the dystopian Soviet Union.
The invasion also reaffirmed the raison d’etre of the European Union. A political project formed to prevent conflict in Europe and a common defence, the marauding Russian bear on its border reinvigorated the political project further.
Finally, it alienated the fringe movements within the US. The ‘red wave’ in the US mid-terms failed to materialise, despite difficult economic conditions.
Perhaps the person most surprised by the outcome of 2022 would be Mr Putin himself. The extent of his involvement in the fringe parties in liberal democracies is unclear, but their interests were certainly aligned: both disliked ‘globalism’ (an idea of a global rules based order that covered trade, human rights and international law). Close allies of Putin, like Belarus facilitating illegal migration to the EU also suggested that he was fanning populism. Until 2022, it appeared the Putin was content with covert, asymmetric engagement, but all that changed in Ukraine.
The risk with dictators is that they surround themselves with sycophants, and perhaps he had bought into the narrative the liberal democracies and the West were weak, and this would be his moment to establish the multipolar world order he had been promoting in speeches over the past two decades.
He failed. If anything, he reinvigorated the liberal, globalist polity, giving it a clear contrast in values. The need for global rules that identify sanctions evading oligarchs, define rules for war, and target war criminals became more plain for all to see.
In the final months of 2022, Putin has resorted to widescale bombing. If using the Battle of Britain as an analogy, Hitler turning his attention to civilian infrastructure was a tactical error, that allowed the RAF respite to rebuild, and further was a sign of HItler’s frustration. As uncomfortable as it is to watch, this change in strategy may be a sign of a lack of options, rather than some astute new plan. With any luck the end is in sight. We will write more about this in our forecast of potential outcomes.
China
It is impossible to grapple with geopolitics without discussing China. As things stand China is one of the big winners of the Ukraine conflict. Xi and Putin had a summit prior to the Ukraine invasion. Exactly what was said may never be known, but a year later China has a nuanced position. It wants military de-escalation, but not an overthrow of Putin.
China too promotes a multi-polar world, but unlike Putin it hasn’t acted rashly to achieve its goals. An isolated Russia now provides essential commodities to China at discounted prices, due to the crippling sanctions regime. The best outcome for China has to be a neutered Putin clinging onto power for another decade, and reliant on China and India and other ‘multi-polarists’ to purchase Russian commodities.
In the intense geo-political sabre rattling, the position of Taiwan made the headlines several times in 2022, but no-one crossed any redlines. By the end of the year it had to reverse it’s zero-Covid policy resulting in a further internal focus, as the painful transition to herd immunity began..
China’s economy is closely linked to the US. It’s currency is in a trading range pegged to the USD, as is the Hong Kong dollar. Speculators have started threatening those pegs, considering them unsustainable.
The rising rates in the US put pegged currencies under pressure, as they are impacted more notably than floating currencies (which can devalue to cushion the changes). Geopolitically, 2022 has been a good year for China. It was able to watch a test run of the various tools at the disposal of the globalist order, and likely got the message that it isn’t ready for a confrontation. If Putin stays in power, then his Ukraine debacle will prove a big win for China, as Russia will be relegated to a client state, that is complementary, as it provides China with commodities and China provides it with manufactured goods, people and technology. If Putin goes, then its a different story altogether.
Oil and commodities
The year started with a commodity price boom. A conflict between two major commodity producers (Ukraine in agricultural commodities, and Russia in energy and metals) was going to disrupt supply.
Add to that a world emerging from a pandemic, and the anticipation of pent up demand, and analysts were calling for $200 oil. So oil prices at the end of the year below $80 must be a surprise to all, including Mr Putin. The Rogers Commodity indices (for all commodities and agricultural are ending at or below the beginning of 2022.
Aside from depleting the US strategic reserves, u-turning on the production of shale oil, the Biden administration also eased off sanctions on Iran and Venezuela. Combined with the some tough talking with the Saudis, the world wouldn’t endure a 1970s style oil spike. The oil speculators who went long were the ones left with a bloody nose. No doubt this also suited China, another major commodity importer, and so it is likely that behind the scenes that China (and India) were on the same geo-political hymn sheet as the US and EU.
Observers have noted how Saudi Arabia started selling oil to China in Yuan shortly after a Biden visit, all pointing to coordinated measures to manage international commodity prices.
Notably, the sanctions regime was pragmatic rather than overzealous. Whilst peripherally targeting Russian exports, the US has turned a Nelsonian eye to breaches of sanctions and non-compliance. This, we think, is deliberate. The only winners of an oil shock would be Putin and Co. Rather, making Russian oil illicit makes it trade at a discount, whilst still allowing oil to reach consumers, and so not spiking the price.
Russian sanctions based on a $60 oil price cap has been the subject of some diplomatic haggling, but with the price on the open market at $80 (well below the $100 the Russian state budget requires), it is largely academic. Russia isn’t earning enough, and everyone else is getting discounted oil. Not what one would have predicted at the start of the invasion. With energy dependency being realigned, and nuclear energy back on the table, time is not on Russia’s (or other oil producers’), side.
Inflation and interest rates
Double digit inflation reared its ugly head in some developed economies for the first time in over forty years. This has led to analysts calling an end to a period termed the ‘great moderation’. From the 1980s onwards, with access to manufacturing in China, and more labour emerging from the other side of the Iron Curtain, along with the ascent of technology to permit offshoring and outsourcing, we have witnessed a steady decline in the cost of production, and with it subdued inflation.
With it interest rates declined from high teens to virtually, if not actually, zero. In 2022 that all reversed. The question is whether that is permanent or not.
On the face of it Mr Putin appears to have caused this sudden spike, but as we point out above, commodity prices are actually coming down. Dependence on Russian gas has of course disproportionately impacted economies reliant on that source of energy, but other sources of inflation have also appeared.
The bigger concern for the price of raw commodities and energy is the systematic shift away from fossil fuels led by changes to the investment framework. ESG based mandates are changing the investment eco-system, and that is a far more consequential shift that is underway.
Analysts also cite, supply disruption and a realignment from (just-in-time supply chains, to just-in-case). The extra capacity has a cost. The pent up demand from the pandemic also contributed, and the real surprise in the US were the amount of job vacancies. The combination of a lack of supply and pent-up demand spiked inflation, but central banks were concerned about ‘structural inflation’ - the idea that consumers expect future inflation and so individuals and businesses make purchasing decisions on that basis.
Keen to nip this in the bud we saw historically aggressive hikes, with the Fed going 75bps a session throughout the year. More anaemic economies haven’t had the luxury of being so aggressive, but the EU, UK and the Japan have all turned hawkish, and signalled a willingness to resolutely combat inflation. This coordinated dampening of demand has also likely impacted falling commodity prices.
The US has set the pace on hikes, and the markets are watching with bated breath for the expected ‘pivot’. The rhetoric in Fed speeches has been hawkish, and the big question now is the ‘dot plot’ - how long the US will maintain this dramatic and new high level of rates. That and the lagging reaction of the economy to this markedly different environment will impact 2023.
UK
Our little archipelago also had a dramatic year. The passing of the popular, and longest reigning monarch in British history, was accompanied by a year with three prime ministers, including the shortest tenure in prime ministerial history, and the first prime minister of Asian descent.
Liz Truss tryst with extreme libertarianism was ended by the gilt market and a surprising amount of leverage in the pensions sector. The Bank of England stood firm on acting according to its mandate, and that made a political u-turn inevitable. Sacrificing her chancellor was insufficient, and this time the Tory members didn’t get a say in the next PM, as PM Rishi Sunak enjoyed a ‘coronation’.
Nigel Farage, a fringe, but extraordinarily successful politician, stated that the ‘globalists are in charge’ and that ‘Brexit was dead’. We agree, or at the very least the libertarian, no-deal Brexit is history. Whilst PM Sunak was a Brexiteer, the noises are that he was always been the voice of economic reason - i.e. not wanting to go down the path of material economic pain in pursuit of a no deal Brexit.
A shift back towards Europe now seems inevitable, both as the popularity of Brexit (or at least the no-deal version the libertarians were implementing) is waning in the polls, and the economic pain that is required to implement that version becomes clear.
Markets
The markets had a tough year, but not as bad as one would expect given the dramatic events that took place. Both a tougher geopolitical climate and a dramatic rise in interest rates would portend a severe crash.
Tech and crypto took the brunt of the punishment, with misbehaviour by errant actors like FTX being outed (as their misappropriation of client funds to bet on crypto for their account became unsustainable with falling prices). However, once again the fall in prices whilst stark at 40% to 80% depending on the asset, was not as extreme as one would expect given fastest US interest rate rises in history.
Safe investment pools like pensions, that held large amounts of bonds were perhaps the notable victims, with many pensions down 20% to 30% as long end government bonds more than halved in value.
For many money managers it was a tough year, likely spending much of their time on the phone explaining why the 40/60 balanced, Sharpe ratio based portfolios were suffering quite so much volatility.
Summary for litigators
For the litigation community, where cases are linked to opacity (of contract) and losses, we seem to be entering a new era. The GFC of 2008 provided a need for litigators services, but in the period since the limitation periods expired cases have expectedly declined.
We now seem to be at an inflection point. Some think it is a change in direction after 40 years of the ‘great moderation’ - a period where geopolitics took a back seat, and we enjoyed a contemporary economic utopia, of free trade, untrammelled supply chains, expanding economies, global labour pools and global consumers.
If such a shift is underway, then we expect a lot more volatility and losses in the decade ahead. For those reading this who are not litigators, in uncertainty there is also opportunity, and we hope that as you join us in understanding these shifting currents our thoughts will help you navigate through the fog of uncertainty.