2022 was one of the most challenging market environments in history – a year in which both the stock and bond markets fell for the first time in decades. And the challenges continued into 2023.
Part of our support for clients includes speaking out on issues important to their investments. I have long believed that it is critical for CEOs to use their voice in the world – and there has never been a more crucial moment for me to use my voice. I will do so whenever and wherever I believe it can serve our clients’ and our interests.
Contact with customers: Identification of short and long-term trends
BlackRock has grown as more and more clients have placed their trust in us, and this growth in turn has allowed us to deliver better results, both to our clients and our shareholders. In our iShares business, for example, we offer over 1,300 ETFs – more than any other company. And since 2015, reducing iShares fees has helped investors save nearly $600 million.
We are proud to be the top performing financial services stock in the S&P 500 since our IPO in 1999, with a total return of 7,700%.
One of Blackrock’s most critical tasks as a loyal investor for our clients is to identify short- and long-term trends in the global economy. We do this in all sectors, including those that are essential for the future of the economy, such as health services, technology and energy. We see many opportunities for our clients to take advantage of market disruptions – rethink portfolio construction, take advantage of the renewed yield potential of bonds, or reallocate investments to sectors that may be more resilient in the face of increased inflation and market distress.
I will note that over the past 20 years, bond ETFs have broken down many barriers to investing in fixed income products, simplifying the way all types of investors access the markets. Bond ETFs have connected the fragmented fixed income market with transparent and liquid exchange trading and provided a way It is simple for investors to buy a portfolio of bonds for a known bid-ask spread and relatively low fees. We believe that ETFs will continue to accelerate progress in the structure of the fixed income market and integrate even more into the fixed income market.
Cracks in the financial system: Inflation not seen since the 80s
Since the financial crisis of 2008, markets have been driven by particularly aggressive fiscal and monetary policies. As a result of this policy, we saw inflation rise sharply to levels not seen since the 1980s. To combat it, the Federal Reserve has raised interest rates by nearly 500 basis points over the past year. That’s one price we’re already paying for years of easy money—and it was the first domino to fall.
Bond markets fell 15% last year, but it still seems, as they say in the old Western movies, “quiet, too quiet.” Someone or something else had to pay the price as the fastest rate of rate hikes since the 1980s exposed cracks in the financial system.
Last week we saw the biggest bank failure in 15 years, when federal regulators took over Silicon Valley Bank. Two smaller banks also collapsed this week. It is too early to know how extensive the damage is. The regulatory response has so far been swift, and decisive actions have helped prevent risks of infection. But the markets remained on edge. Will a mismatch between assets and liabilities be the second domino to fall?
Previous rate hike cycles have often led to spectacular financial conflagrations—whether it was the savings and loan (S&L) crisis of the 1980s and early 1990s, or the municipal bankruptcy of Orange County, California, in 1994. In the case of this S&L crisis There was a “slow-rolling crisis” – one that just kept going.
We still don’t know if the effects of easy money and regulatory changes will trickle down to the entire US regional banking sector (similar to the S&L crisis), with more government shutdowns and takeovers. It appears indeed inevitable that some banks will now have to pull back on loans to strengthen their balance sheets, and likely We will very likely see tighter capital standards for banks. In the longer term, today’s banking crisis will give greater importance to the role of the capital markets. As banks may become more constrained in their lending, or as their customers wake up to the mismatch between assets and liabilities, I expect them to turn in large numbers More to the capital markets for financing.I imagine many corporate finance managers think about clearing their bank deposits every night, to reduce even one night the risk.
And there is still a chance that the third domino will fall. In addition to duration mismatches, we may now also see liquidity mismatches. Years of lower interest rates have led some asset owners to increase their commitments to illiquid investments—trading lower liquidity to achieve higher returns.
As long as inflation remains high, the Fed will remain focused on the war against it and will continue to raise interest rates. While the financial system is clearly stronger than it was in 2008, the monetary and fiscal tools available to policymakers and regulators to deal with the current crisis are limited, especially with a divided administration in the United States.
With higher interest rates, governments cannot sustain the levels of fiscal spending and deficits of previous decades. The U.S. government spent a record $213 billion in interest payments on its debt in the fourth quarter of 2022. Up $63 billion from a year earlier. How quickly markets react when investors lose faith in their government’s fiscal discipline.
After years of global growth fueled by high government spending and record low interest rates, the world now needs the private sector to grow economies and raise the standard of living of people around the world. We need leaders, both in government and in corporations, to recognize this necessity and work together to realize the potential of the private sector.
Economy of fragmentation: Flexible supply chains and investment in national security
These dramatic changes in financial markets are occurring at the same time as equally dramatic changes in the not-so-pastoral landscape of the global economy – all of which will keep inflation high for longer.
Last year, I detailed in a letter to shareholders about the profound changes in globalization that will be seen in 2022 as a result of Russia’s invasion of Ukraine. The seeds of a backlash against globalization were planted long before this war in Europe.
The corona isolation intensified this charged environment and led to protectionism and hyper-polarization. Workers want to connect with their companies and citizens want to believe in their governments, but polarization and fragmentation have eroded trust and diminished hope.
The pandemic has highlighted the need for flexible supply chains. The issues of national and economic security climbed to the top of the order of priorities.
Whether it’s food and energy or computer chips and artificial intelligence, companies and countries are looking to ensure they don’t depend on a supply chain exposed to geopolitical tensions. Countries want to find essential products close to home, even if it means higher prices. These changes produce a global economy that is less integrated, and more fragmented. Public and private sector leaders trade efficiency and lower costs for resilience and national and economic security. This is understandable public policy, but it is important that investors recognize the risks and opportunities it creates.
Governments play a greater role in where products can be obtained and where capital should be allocated as they seek to keep the production of critical components within their borders. This means that capital will not necessarily be allocated to businesses that provide the maximum return on the market, regardless of where they are located.
In the near term, the effects of the trend are very inflationary. This trade-off between cost and security is one of the reasons I believe inflation will continue and become more difficult for central bankers to rein in over the long term. As a result, I believe inflation is likely to remain closer to 3.5% or 4% in the coming years.
silent crisis: Building a hopeful future for retirees
The world is facing a “silent crisis” when it comes to retirees, but it’s not part of the political dialogue in most countries and corporate leaders rarely discuss it. It doesn’t make headlines or attract attention because it’s not this year’s or even next year’s problem. But it’s a crisis. And the more we postpone the discourse on this, the crisis will grow.
To deal with the crisis, we need to understand some of the issues driving the retirement crisis both globally and locally. Populations in Europe, North America, China and Japan are aging due to increased life expectancy and declining birth rates. This has profound implications for each of these markets over time. This will cause a smaller working population and income to grow more slowly or even fall.
States and companies should pursue a “productivity imperative”. Successful countries will be those with higher healthy life expectancies, higher labor force participation rates and higher fertility rates. Successful companies that generate durable returns for shareholders will be those that manage to find enough employees, employ them at high productivity rates and find enough customers.
Investment for the future: An act of hope and optimism
Hopelessness, especially as we enter a period of economic uncertainty and weakness—if not a full-blown recession—may be one of the biggest barriers to turning savers into long-term investors.
Levels of trust in financial institutions and hope for the future vary greatly from country to country. Even in the US, where the stock markets have been a huge success story over the years, only 58% of Americans are invested in the stock market. Americans and others around the world who invested $1,000 in the S&P 500 index 10 years ago would have more than $3,000. For a mattress or an empty coffee can, the $1,000 will be worth even less after inflation, that’s the power of investing.
In the near term, monetary and fiscal policy will be the main driver of yields. In the long term, investors should also consider how the energy transition, among other things, will affect the economy, asset prices and investment performance. According to Munich Re, insurers were forced to pay out $120 billion in insurance money on natural disasters in 2022 – a figure that was once unthinkable.
I wrote last year that the next 1,000 unicorns will not be search engines or social media companies. Many of them will be sustainable and with scalable innovation – startups that help the world decarbonize and make the energy transition available to all consumers. I still believe it. Our approach to investing in the transition to a carbon-free world is the same as our approach across all our platforms: we provide choice to our customers; We look for the best risk-adjusted returns within the mandate that the clients give us; And we base our work on research, data and analysis.
Digital assets: The obsession of The media for Bitcoin
If there is one part of financial services that has grabbed the headlines in the past year, it is digital assets, not least because of the collapse of the FTX. Beyond the headlines – and the media’s obsession with Bitcoin – very interesting developments are taking place in the field of digital assets. In many emerging markets – such as India, Brazil and parts of Africa – we are witnessing dramatic progress in digital payments, reducing costs and promoting financial inclusion. In contrast, many developed markets, including the US, are lagging behind in innovation, leaving the cost of payments much higher.
For the asset management industry, we believe the operational potential of some of the underlying technologies in digital assets could have exciting applications. In particular, the tokenization of asset classes offers the possibility of increasing efficiency in capital markets, shortening value chains and improving cost and access for investors.
We see that the role of fixed income in the portfolio is growing – for the first time in years, investors can earn very attractive returns without taking much time or credit risk. Institutions and individuals aiming for something around a 7% return have had to manage allocations between stocks, bonds and alternatives to try to reach that return. Today, they can meet this goal by investing almost entirely in bonds. We also believe that recent concerns about the security of cash in bank deposits will further accelerate the demand for the cash management options we provide.
Writing this letter is always an opportunity to reflect on the past year and think about what the future may bring. When I wrote last year, Russia had just invaded Ukraine, globalization was moving, inflation was rising and interest rates were about to rise sharply. The world is still dealing with many of these changes and the accompanying market volatility.
My deep belief in the power of the capital markets and the importance of investing in them is as strong as it was when we founded BlackRock 35 years ago.