Glad It’s Over
It is probably a safe assumption that most anyone has had at least one experience they are glad when it is over. Often the experience may not necessarily be bad, such as a long vacation, and you might simply be glad to be back home. However, the majority of the time when this phrase is uttered it is because somebody is truly happy that something is finished. When it comes to the markets, few would not agree they are glad 2022 is over.
The most widely followed stock index, the S&P 500, finished with a loss of 19.4%; its worst loss since 2008 when we were in the midst of the financial crisis. This was a painful reversal after a gain of nearly 27% in 2021. It was even worse for the tech-heavy Nasdaq composite which dropped 33.1%. The Dow Jones Industrial Average fared better with “only” an 8.8% loss. From a historical perspective this was the 7th worst year for the S&P 500 going back to 1926.
Stocks began their descent early and generally struggled all year, save for a few rallies which failed to materialize into longer term upward trends. Inflation put increasing pressure on consumers and the Federal Reserve quickly raised interest rates to fight higher prices. Concerns were raised about global economies slipping into a recession as a result of higher interest rates. The Fed continues to walk a thin line between raising rates enough to cool inflation but not so much they stall the U.S. economy. Russia’s invasion of Ukraine in February worsened inflationary pressure by making oil, gas, and food commodity prices even more volatile amid existing supply chain issues.
Growth stocks, especially those with inflated valuations, fared worse than value stocks since growth stocks tend to be more sensitive to interest rates. A stock’s price is generally predicated on prospects for future earnings. Discounting future cash flows to present value using higher rates leads to lower current stock values. Energy was the lone bright spot in the market as the sector returned nearly 60% for the year. Technology, consumer discretionary, communications and real estate were laggards.
It Won’t End Fast Enough
It was a rough year for the stock market, but it was equally bad for the bond market which suffered its worst losses in history, by a wide margin. The Bloomberg Barclays U.S. Bond Aggregate Index lost 13% and longer term (20+ year maturity) Treasuries lost a whopping 30%. For many years we’ve been taught about the advantages of diversification and how bonds can protect against stock market loss; a strategy that has historically worked well – until it did not. This really should not come as a big surprise since interest rates were near zero a year ago so the only direction to go was up. Bond prices move inversely to bond yields, so prices will fall as yields move higher. The only surprise may have been the stubbornness of inflation which led to interest rates moving much higher than most anyone imagined or anticipated.
The Federal Reserve moved the Fed Funds rate from near zero to over 4% during the year; the fastest rate hikes since the late 1970’s. Indications are they are not finished yet. Inflation is moderating but remains well above the Fed’s comfort zone, as well as the comfort level of most consumers as monthly household budgets continue to be strained. We anticipate rates to move higher over the next year; albeit not at the same pace or to the same magnitude we experienced in 2022. Therefore, we continue to remain cautious on the bond market. For those investors holding fixed income funds in hopes of a recovery, even if the bond market stabilizes and we do happen to see a drop in interest rates, it seems highly unlikely losses will be quickly recouped. We would encourage investors to consider other strategies for protecting their wealth or providing income.
With 2022 now behind us, we look ahead to 2023. Prospects of a recession loom large, perhaps the most widely anticipated recession in history judging by the current consensus of economists. The stock market was driven by action from the Federal Reserve in 2022, with many strategists believing this will continue to be the case in 2023. However, we think the stock market will be driven more by earnings. We anticipate the Fed to continue to raise rates, although at a slightly slower pace, during the early parts of this year. But earnings growth (or lack thereof) is likely to be a larger market driver since if we do enter a recession, earnings are likely to drop. We may see some indicators of this when earnings reports for the fourth quarter begin to be released towards the middle of this month.
Inflation and interest rates will continue to be monitored closely and we see a possibility of the pace of reported inflation to drop quickly given how it is currently measured. Also, recessions tend to be deflationary since reduction in demand occurs. But even if this were to happen, we would not expect a quick pivot from the Fed and we anticipate inflation to remain elevated above historical levels for many months, if not years, to come. With the prospects of a recession and further Fed action, we will likely see continued volatility in the markets, especially during the first half of the year. This may prove to be a very good buying opportunity. As we saw in 2022, sector and stock selection had a large impact on returns and many active strategies outperformed passive strategies. We anticipate this to continue into 2023.
It seems premature to make predictions about the second half of the year, especially given all the variables, but we are cautiously optimistic that better times are ahead. We think it is unlikely we will again experience the double-digit growth that we did over the past decade, but any sustained move higher would be welcomed. If you are fully invested, we would encourage you to remain so, being patient and not losing sight of your long-term goals. Timing the market well has proven nearly impossible and by jumping out now, you would risk a possible rebound. With a recession being so highly anticipated, there is a likelihood it has already been priced into the market. But if one were not to occur, we could see a positive reversal in the markets.
Here at Secured Retirement, we remain committed to doing what we always have – ensuring you feel confident in your retirement regardless of what happens in the markets. If you, or anyone you know, would like to discuss your individual situation in depth do not hesitate to contact us. We want to ensure you are well prepared for what lies ahead.
Best wishes for a happy, healthy, and prosperous 2023!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
Please contact us if you would like to review your individual financial plan or learn how the TaxSmart™ Retirement Program can help you.
Office phone # 952-460-3260