Global Stock Markets Lost $25 Trillion in 2022 amid Perfect Storms

The market may appear gloomy with world stocks down nearly 9% for their worst start to a year in over 10 years, emerging market currencies declining and low-risk U.S. government bonds and gold XAU= up 16% respectively.

However, there is more to the global equity markets story than meets the eye. Despite all of the uncertainty that has beset global economies, corporate profits have managed to stay relatively resilient.

China's Covid surge

Global stock markets suffered a massive loss of $25 trillion in 2022 due to global trade wars, rising energy costs and an economic crisis caused by China's COVID outbreak. Investors have fled China-linked stocks and the yuan has appreciated, suggesting that "investors are turning ice cold on China," according to Stephen Innes of SPI Asset Management.

Due to the global economic downturn, many governments have implemented new restrictions on Chinese goods - particularly oil. As a result, Chinese exports have seen an immediate and drastic decrease, contributing significantly to US trade deficits and growth.

China, the world's second-largest economy, is in a prolonged economic downturn. While President Xi Jinping has taken bold measures like cutting interest rates and encouraging capital flight, there remains the danger that the country could slip back into recession due to lingering supply chain disruptions.

Global economic growth has been weak for years, and the World Bank recently cut their forecasts for this year and next. As a result, Chinese stocks have suffered and yuan trading volumes have collapsed.

On a positive note, the reopening of China's factories has given some encouragement to an already fragile economy and should boost consumer spending. However, analysts warn that it could also cause an uptick in inflation rates.

Last week, the yuan experienced its weakest level in three years and trading volume on Shanghai's main stock exchange dropped to its lowest since April. A trader at a state-owned lender who spoke on condition of anonymity because they weren't authorized to discuss such matters reported that this is the first time in five years that yuan/dollar trading volume has fallen below $20 billion.

As a result, global stock markets are now declining, prompting some economists to wonder if we may be headed for another recession. As of Tuesday, global economic growth had declined to 2.7% - its slowest pace in nearly half a century.

The World Bank has revised down its growth forecasts for this year and next, due to China's COVID outbreak impacting property sector weakness and a sharp drop in exports. Now, they predict China's economy will expand 3.7% in 2020 and 3.8% in 2021.

Tech tantrums

One year ago, global stock markets had reached their peak and the Nasdaq was on fire. Investors were betting on new tech companies and high-flying IPOs like Tesla or Rivian that brought in record amounts.

But as the year went on, things began to shift. The Fed announced its intention of ending quantitative easing program, prompting what became known as a taper tantrum - an extended market panic that lasted a few days.

This was the first time central banks had reduced their support of bond purchases in a staggered fashion due to the global economic crisis, intended to help boost growth and employment levels.

In other words, the taper tantrum marked the end of the 'bubble' created by Fed's stimulus efforts and sent markets into a tailspin. Although its impact was short lived, it created the precipice for what is now widely acknowledged to be an earnings recession.

In 2022, the S&P 500 experienced a substantial loss of 19% despite its slight recovery in December. Technology stocks such as Tesla and Meta were particularly hard hit, while traditional sectors like energy were able to slightly lift the index up.

Thankfully, some simple steps can help make the transition smoother and avoid tech tantrums from developing. Dr Kristy Goodwin, digital parenting and wellbeing educator, speaker, and researcher explains:

1. Define Expectations and Consequences with Clarity

It is essential that you communicate your media rules, such as how much screen time children are allowed each day, along with any consequences if they don't adhere to these guidelines. Make sure all children understand these expectations prior to any screen time they have each day.

2. Be consistent and fair in your enforcement of rules, even if it appears that a child may be struggling to follow them.

3. Utilize parental control apps to help limit screen time and create an appealing transition activity when it's time to disconnect.

4. Avoid punishing or humiliating children for their behavior.

No central banks riding to the rescue

Last year, a massive sinkhole of more than $30 trillion from global stock and bond markets consumed an unprecedented amount of wealth and optimism. It reversed everything the world had been trying to suppress since the turn of the millennium; it brought back wars and inflation that an entire generation had grown up with; ultimately erasing decades worth of financial market gains and hopes.

Central banks are essential financial institutions that shape the global economy through effective monetary policy and smooth operations of financial markets. As the dynamics of globalization change, so too must their role.

They do this by intervening in the markets to guarantee that interest rates match up with authorities' objectives. Typically, this involves selling securities to the market until commercial banks reduce their currency holdings according to central bank goals; then these depleted reserves must be offset by decreased deposits from affected institutions.

Important to remember is that these decisions are independent from political groups in power; rather, they aim to preserve financial stability. If authorities feel uncomfortable with the level or term structure of interest rates, then they will have no choice but to take action to bring it back into line.

The size of the open market for security transactions is essential in this process. If it is small, central bank interventions will be limited to securities offered by a few intermediaries and won't provide much help to authorities in getting their desired interest rate level and term structure.

When the open market is large, a central bank's intervention can be much more successful. This is because many other market participants will take advantage of securities offered at abnormal discounts as they anticipate that the central bank will soon buy to correct the price deviation.

The upcoming earnings recession

The global economy has been battered by a series of adverse shocks, from COVID-19 to Russia's invasion of Ukraine. Taken together, these events sent stock markets into a tailspin and caused an unprecedented global stock market wipeout of $25 trillion.

Earnings are a major driver of the stock market, but they're not immune to negative surprises during recessions. Since 1930, S&P 500 earnings per share (EPS) have fallen below trend on average during periods of economic uncertainty.

Profit margins are strongly related to labour costs, and wages in the economy remain tight. Therefore, profit margins will need to adjust accordingly as wage growth slows in 2023.

Mike Wilson, an equity strategist at Morgan Stanley, noted that a decline in earnings is often the first indication that an economy has entered recession. Accordingly, companies will likely need to reduce their forecasts for next year.

Wilson noted that the market has yet to factor in an earnings recession into its valuation, giving investors time to act if needed.

This season's earnings report is likely to reveal that cost pressures remain high and consumer demand is slowing. These two factors will put strain on profitability, potentially sending shares lower.

Bloomberg Intelligence strategists anticipate earnings expectations to decline this year and in the first half of 2023. If true, this would signal the start of what's likely to be the worst earnings recession since 2008.

EPS tend to be positive during late-cycle expansions and reach a trough when the economy enters recession. On average, consensus EPS have fallen 10% below their trend rate during recessions over recent decades.

According to this forecast, EPS for the first quarter of 2023 should drop to around $176 a share from the S&P 500's bottom-up Q4 EPS estimate of $208 in 2023.

Corporate earnings could suffer, making it harder for the market to recover as the economy enters recession. Nonetheless, bear in mind that markets typically experience strong rebounds at the end of a recession.