At the beginning of 2022, no one would have expected the year to turn out so badly.
Initially, we expected the year to be dominated by the news of the COVID recovery, but as the year progressed, everything changed when Russia attacked Ukraine. The series of rapid increases in interest rates ruined all hope for a year of stellar performance, and the S&P500 was down 19.4% for the year.
If you benchmark the ERM portfolio against US stocks, or even bonds, ERM would have performed well. Unfortunately, our benchmark was the STI index, and this was the first time ERM underperformed by a huge double-digit margin!
All the disadvantages of the STI index became advantageous in 2022. 45% of capital invested into banks allowed the index to outperform the world as banks could profit from higher net interest margins in 2022. But making matters worse for ERM, factor models could not predict the outperformance of oil-related stocks like Keppel Corp and those going through restructuring.
This combined reversal of fortunes was what ultimately undid the portfolio.
As ugly as things are, the beauty of defensive investing with a focus on value factors is that every year that we do poorly, our odds of outperformance the following year improve. As we get deeper into the downturn, the latest back-tests have shown outperformance of value factors like low PE ratio, low PB ratio and high dividends. Our yields are now above 6%, with later batches of students getting over 7% with the portfolios they build.
2022 was also notable for the time I told students that I was pulling out all my leveraged student portfolios on 26 September 2022, and we avoided a 7% dip after that, which could have led to painful margin calls for some students. Now the portfolio is trading about 2% below where we withdrew from the markets and is heading up.
February 2023 should be about when leverage will slowly return to the ERM programme as I start afresh with a portfolio for our 29th batch of students.
There are reasons for 2023 to be a better year than 2022:
- Interest rates will likely stop rising this year.
- We will have a shallow recession before things start turning around.
- COVID recovery will begin to gain momentum once cases in China peak.
Since we do not know when markets will bottom out, the best approach would be to buy every time interval until things get better.
In summary, 2022 is the year investors like to forget, but if you think about it, this is the time to pick high-yielding stocks at a discount.
