The Year in Review

If this were late 2012 and some prescient director were to make a movie about the US business world set a decade hence, viewers of the time would almost certainly scoff at the far-fetched plotline. The movie would open in the third year of a pandemic, with a war in Eastern Europe and oil prices bouncing between $80 and $125 a barrel, natural gas prices swinging between $3.40 and $9.70 per million BTUs domestically and the S&P 500 losing 20% of its value.

Inflation would peak at 9%, and something called cryptocurrency would be cratering as the year closes. Who wrote this script?

Meanwhile, on a cheerier note – and in the same script, the year starts out with a public company’s (Apple) value exceeding $3 trillion and the unemployment rate hovering between 3.5% and 4%. To give viewers an emotional break, we show supply chains starting the year a colossal mess and ending with a return to normalcy — barring a rail strike or Chinese regional shutdown plot twist. Gas price averages drop below $4 after peaking above $5. NASA heads back to the moon, and its new space telescope tells us more about the universe than we’ve ever known.

So what’s this movie about? Is 2022 presaging a dystopian Mad Max reality where energy is the stuff of fights and wars, or is it more of a utopian Gene Rodenberry world where technology and common cause unify humanity for the good of all?

Those are two possible but unlikely endings. More likely it’ll be one of those cliff hangers that requires a sequel and then another and another. Here’s a look at the unlikely journey that was 2022 and some advice for what to do regardless of what comes next.

Energy

Russia’s invasion of Ukraine means energy has been and will be a much bigger issue than it would otherwise have been. Oil prices move globally, but natural gas prices don’t. So while US consumers see natural gas up about 50% by the end of the year, the EU and UK have seen prices spike by a factor of ten since January. They’re just now starting to fall back as European storage facilities have refilled — now to 95% of capacity.

It’s likely EU natural gas will fall a bit further, but prices there will remain many times higher than in America. Asia’s natural gas prices look much more like the EU’s than ours, and thus exerts far greater inflationary pressure in those markets than it does here, implying our inflation may be more easily addressed than in the rest of the developed world.

As for oil, the Russian invasion and the world market reaction to it sent prices rocketing up, contributing to global inflation. Prices have settled back to levels that are high for recent years, but comparable to 2014. With Russia largely sidelined, OPEC holds more sway over oil prices than it has in recent years. It seeks to walk a fine line of driving revenue but not pushing prices so high as to accelerate new drilling around the world or worse, faster moves toward alternative sources of energy. If OPEC has its way, oil will remain around $80 per barrel.

Our Advice: Continue to hone those scenario planning skills, including how to include a continued volatile energy landscape in your forecasts. You’ll need multiple forecasts that consider the different scenarios, because as 2022 has shown us energy costs will remain volatile.

Nasdaq index of global oil prices for 2022

Global Supply Chains

For two years now, we’ve all watched with consternation as ships lay at anchor for weeks waiting to unload cargo while importers gritted their teeth and paid astronomical rates for shipping containers in virtually all parts of the world. In particular, costs for containers from Asia to anywhere in America spiked by as much as a factor of ten late last year.

Now, the ports of Los Angeles and Long Beach report a more normal queue of ships in harbor, and prices for containers have come down substantially (chart below). Unraveling what happened and how supply chains are coming back to some new normal is complicated, but the good news is that, particularly for exports from Asia to the US West Coast, container prices are nearly back to pre-pandemic levels.

The US consumer’s return to a desire for both goods and services is certainly a major contributing factor. So, what’s good news for importers is likely bad news for holiday travelers. This year’s Thanksgiving travel by air exceeded pre-pandemic levels. Roadways too are increasingly crowded. The desire for experiences is now back in better balance with the desire for stuff, so is our share road rage.

Meanwhile, the US census bureau expects holiday sales to grow by 6% to 8% this year after shooting up 13% last year. Retailers say they’ve largely been able to get the goods they want in time for the season. The expected sales volume increase for 2022 looks pretty great compared to the decade after the Great Recession, but not as good as the last two years.

Our advice: The importance of perfecting stock levels is so critical now – not overbuying and tying up capital in what could be hard-to-liquidate inventories.

Globalization

If global supply chains are returning to predictability, does that imply globalization is alive and well?

Here’s where the plot gets complicated — really complicated. The actions in recent months of large trading partners around the world should remind us that our interests are not necessarily their interests.

The world is recalibrating its relationship with Russia after perhaps the worst European geopolitical miscalculation since WWII. It’s been costly and complicated as the West has done its best to take Russia out of world economics.

No one’s watching more closely than Beijing.

China has been clear that it too sees its regional influence growing, and in ways that make the West uncomfortable. Whether it’s claims on Taiwan or influence over its neighbors and, increasingly, working with developing African nations, China is now an omnipresent rival to the United States. Tight lockdowns resulting from its zero Covid policy also certainly continue to put a crimp in US supply chains. China’s interests very clearly are not the same as ours.

The United States has responded with the CHIPS and Science Act, which passed the US Senate by a vote of 64-33. The bipartisan act seeks to rejuvenate computer chip fabrication and R&D on these shores. For the semiconductor industry, the bill will spend some $52.7 billion on R&D, manufacturing and workforce development. So far, Micron, Qualcomm, Intel and others have announced new manufacturing plants that will leverage CHIPS money.

The act also spends some $200 billion to create high-tech hubs and STEM training for other R&D and technology commercialization over a 10-year period. McKinsey expects semiconductors alone to become a $1 trillion industry by the end of the decade, and lawmakers want that money working here not abroad. The bill is huge and focused, and the bipartisan support comes because too much of the world’s high-end chip capacity sits in China’s backyard, making it a national security issue.

Punctuating that, president Xi Jinping has ordered China’s armed forces to modernize by 2035 with the goal of being able to fight and win big wars by 2049. It’s that kind of talk along with the pandemic era shortage of chips that led to the CHIPS act. It’s also the kind of talk you don’t want to hear from your largest trading partner. If your biggest supplier took this stance with your business, you’d diversify — and do so fast. Look for the federal government to follow that thinking. Tariffs and tough talk are now the norm.

Inflation, Interest Rates and the Fed

The now famous economic retreat and recovery of 2020 was due in great part to the quick stimulus responses of the Trump administration and the Fed pumping cheap money into the economy. The Fed not only pushed its short-term interest rates to near zero, it also became, by far, the largest buyer of home mortgages and government debt in the United States.

The chart below shows the growth of the Fed’s balance sheet from under $5 trillion to roughly $9 trillion at the start of this year.

Shortly into 2022, the Fed governors acknowledged what many in the private sector had been saying: Inflation was not just a transitory effect of supply chain issues caused by pandemic-driven changes in consumer demand. Inflation was now an entrenched part of the US and other economies. Blame a combination of some of the effects we’ve talked about here, a bit of corporate greed, and the Fed’s efforts to keep the economy humming.

Because interest rates were already low in 2020, the Fed became a buyer of debt. Quantitative easing, as it’s known, is a fancy term for buying all those mortgages and treasuries.

Now, with inflation a concern. The Fed is not only pushing up interest rates, it’s also actively shedding assets from its balance sheet — effectively removing money from the economy and making borrowing more expensive – a pretty good one-two punch to inflationary pressures.

When the Fed increases its interest rates, other lenders follow. It’s a known pattern that’s been used to fight inflation for decades. Quantitative tightening is a trickier proposition. For the Fed to sell assets from its balance sheet, there needs to be a buyer. The Treasury Department also needs to sell its debt, and now the Fed is not only not a buyer, it’s a competitor. If too few buyers show up, the market becomes illiquid, and that’s a Mad Max scenario for currency markets. See the undoing of former UK prime minister Theresa May.

So, as you can see in the chart above, the Fed sells far more slowly than it bought. It also loses money on each sale.

The Fed was not the only central bank expanding its balance sheet in recent times. As a percent of annual GDP, the Fed’s holdings are somewhat lower than average for large central banks, standing at 34% of GDP at the end of 2020. Japan’s central bank’s balance sheet exceeds 120% of its annual GDP. The European Central Bank holds assets worth about 59% and the Bank of England holds 40% of their respective GDPs. Prior to the Great Recession, central banks would have commonly held assets worth about one fifth of what they’re holding now.

Even with active selling by the world’s central banks, it will take decades to reduce balance sheets to the levels seen prior to the Great Recession. If central banks adopt that goal, the world will not see the low interest rates of the last decade for a very long time. So, while a 6% 30-year mortgage rate sounds outrageously high by recent standards, it’s pretty reasonable compared with rates over the last 50 years and could become the new normal again.

Will interest rates start to look more like they did in the first decade of the millennium? We’re not foolish enough to venture a guess, but at least for now, they do. That’s bad news for even the best run tech companies, which tended to gorge themselves on cheap money. Even Apple’s market cap is down 20% from its peak.

Our advice: Cash is still king and will be for a long time – so business changes that improve cashflow will pay dividends.

The Crypto Winter

And finally, 2022 brought us the most recent rise and fall of crypto – it’s happened twice before. FTX, Celsius, Blockfi and Voyager have made it a great year for law firms specializing in Chapter 11 proceedings. It’s easy to look back at 2022 and say it was all predictable: The promise of crypto currencies and technologies like blockchain are both real and difficult to understand. So, well-intentioned people do their best to bring that “real” promise to life, while less-well intentioned people trade on the hard-to-understand part.

Crypto poster child FTX’s founders and executives, it appears, fall into that latter camp. Investigators now simply can’t find billions in assets, and when they can, they sometimes come in the form of extensive land holdings in the Bahamas and other questionable investments.

Every gold rush has its unscrupulous profiteers. New tech is just the latest fertile ground for get-rich-quick schemes. But that doesn’t mean that good companies with great business models won’t emerge. Those of us with long memories and graying hair will recall the dot.com bubble at the turn of the millennium. As captured by the NASDAQ composite index, the similarities are remarkable. Certainly the NASDAQ’s current retreat has a lot more to do with interest rates than it does with the crazy crypto market, but the boom and bust cycle is clear.

NASDAQ in blue, S&P500 in purple

The dotcom era ended in 2001 and left dozens and dozens of companies in Chapter 11, but it also created Paypal, Salesforce and, well, NetSuite — three companies that are highly respected and successful now. In all likelihood some great fintech/crypto companies will continue to evolve their products and grow to change industries. It’s just not going to happen this year or next.

Like every good Hollywood blockbuster, the 2022 movie closes leaving more questions unanswered than answered. How far will the Fed need to go in its efforts to stem inflation? Will US companies diversify their supply chains and rely less on China for the goods they need? Can Russia find a way to extricate itself from a war it should never have started and will the West let it back into its economic club if it does? And what of climate change, unions and mutating viruses? We hope we’ll live in less interesting times, but we sure wouldn’t count it. Our advice? Go buy some cloud-based ERP gear to manage through it all. It’ll help.