After many years of low inflation and FED induced historic low interest rates, things took an abrupt turn in 2022. While there are other issues we will discuss below, these were the main drivers last year in the markets. The S&P 500 suffered it’s worst loss since 2008 (down 18.1%), while the tech-heavy Nasdaq suffered a loss of (32.54%) and many stocks (like Amazon) were down much more than this (down 50%). This was a big change after a decade of tech / growth outperformance. What made it feel worse is that we experienced the worst year decline in bonds / fixed income in modern history, down (13.01%). Worst year before 2022 came in 1994 (down 3%). Outside of just a few asset classes (energy, utilities, cash), there wasn’t a lot of places to hide with 93% of asset classes losing money. In the last 20 years, this is only 2nd to the 94% of asset classes losing money during the 2008 financial crisis.
Quick recap of 2022:
- The FED takes center stage: After keeping rates artificially low for the last 13 years (since the 2008 financial crisis) the FED signaled they would raise interest rates to combat the worst inflation seen in over 40 years. The original FED guidance of increasing to .75 by year-end 2023 was missed by a wide margin since they actually increased rates over 400% to the range of 4.25% to 4.5%. This came after the FED finally admitted that inflation wasn’t just “transitory” as they did for almost a year and instead was a major problem that became their number one priority. The market (and most all of us) got used to low rates and easy money for a long-time and when the FED took the punch bowl away, the market reacted negatively.
- This interest rate increase caused the 30-year mortgage to jump from what we were accustomed to (3.3% on 12/31/2021), to more than doubling to 6.34% as of 12.31.2022. At one point in the later part of the year, interest rates touched over 7% before coming back down some. This rate increase caused housing to slow considerably from the red-hot market seen during the post-Covid boom. While it has caused short-term pain and housing to slow, it is most likely healthier in the long run for the overall economy after we deal with the shock of the rate increase. We just lived through the lowest interest rate environment in history and having rates at 4% or even 5% is arguably a healthier environment than 2%. Witnessing the dramatic increase in rates in 2022 is unsettling but will potentially cause activity to pick up if rates come down some in the coming year or so.
- Inflation: One thing we all feel very much every time we go to the grocery store, fill up at the pump, buy an appliance or used car, book a flight, etc. is the 40-year high inflation. So far, the increase in inflation saw a peak in June at 9.1% and has been coming down some since (down to 6.5% increase in December 2022), albeit still much higher than a couple of years ago. Remember, however, these figures are simply the increase and if the 1 year rolling data is now including these already higher figures from a year ago, even if it is cooling off, it is cooling off from 40-year high levels and could remain stubbornly high when compared to the past 10 years. But, the market is focusing on the trend and that trend does appear to be coming down, which is a good thing. We have said it a few times in our writings but we are now paying the price for: the FED keeping rates artificially low since the 2008 financial crisis but then accelerated inflation dramatically by the grand experiment of shutting down the global economy during Covid and injecting $6 trillion into the world (this is compared to $700 billion in bailouts during the financial crisis). To make it worse, Russia invades Ukraine and to add to the awfulness of war, it further disrupted supply chains (energy from Russia, food, etc.) When you lay it out plainly, hopefully you can see why we are currently paying higher prices…. But again, hopefully we have seen the peak and prices are hopefully beginning to come down.
- Economic Growth: Despite the stock market having a really tough year, the economy is projected to have grown at 3.8% for the year. (1.6%) 1st qtr (.6%) 2nd qtr, 3.2% 3rd qtr, and 2.9% for the 4th qtr. Keep in mind it is normal to think / assume growth is slowing from the artificial high after the Covid shutdown and re-opening and FED cash infusion. There was nothing “normal” about this period so it is difficult to predict the path out of it.
- Company earnings Growth: While company earnings are the lifeblood of the stock market, it doesn’t always work hand-in-hand as the S&P500 earnings grew in 2022 and we know this earnings growth didn’t translate to positive stock market performance. This same thing occurred in 2018. Company earnings grew by 18% in 2018, while the S&P 500 had a tough year (down 4%), Smallcaps (down 11%), and International stocks (down 13%).
Outlook for 2023 & beyond: While there is uncertainty in the air and even frustration and in many ways feels out of our control, we would encourage you not to dwell on this. Instead, we encourage you to focus on the positives, the things you can control, and maybe what is to come. You rarely meet a pessimistic person who is successful…. or joyful for that matter.
- The FED: While they have enacted the most aggressive interest rate increase EVER (fact check) in 2022, they are most likely closer to ending their rate hikes and already projecting RATE CUTS by 2024. Many think they went too far too fast and things are slowing quickly (think housing) and any sign of them stopping or simply slowing, the market has welcomed this news with applause.
- Inflation has most likely peaked and cooling off some from 40-year high levels due to the FED’s aggressive rate hike in 2022. Plus, continued improving supply chains and overall conditions from the Covid lockdowns should help. Although inflation will probably stay stubbornly higher than we have seen in the last 10 years for 2-5 years to come.
- Mortgage rates: They remained artificially low and we got used to having historically “cheap money” to borrow. In December 2022, housing slowed the most since 1996 and showing signs of continued slowing… So where is the good news here? Interest rates have most likely peaked (10 year Treasury yield, which influences mortgage rates) and since the FED is already talking about RATE CUTS in 2024, this should drive interest rates back lower, potentially causing a wave of refinancing and housing activity, even if they don’t come back down to the historic levels that we saw in the previous decade.
- Yield / income is back…. For the last 13 years (since the financial crisis), banks paid pennies on the dollar for cash / savings / money markets. Now, however, you can actually earn something on your cash again with some money markets paying over 4%. *Many banks haven’t caught up to this yet, so if you have cash earning much less than this, give us a call.
- After a market sell-off: Stocks rarely lose money 2 years in a row. Looking at history, after a market sell-off, coupled with falling inflation, the market has gained on average 24%. Exception years being (1981-82 and 2002). With 93% of asset classes negative in 2022 and many individual US stocks experienced much steeper losses than the broad markets WHEN things rebound, there are certain asset classes & equities that are showing signs of rebounding in a dramatic manner (high growth, innovation, small caps, International, etc.) We are not giving the “all clear signal” but remember, the sky doesn’t go up OR DOWN forever. Typically, when things have a really tough time, good days will come again and the rebound can be swift.
- Small Cap stocks have experienced a lot of pain over the last couple of years and are trading at 20-year valuation lows, when compared to Large Caps. While this doesn’t guarantee immediate results, it may be a nice setup for future success.
- International Stocks: The US has been dominant the last 13 years (especially in Large Cap Growth & Tech), outperforming the overseas markets. While there are certainly challenges overseas with their economic growth, we could be in the early stages of the tides turning away from the US dominance. Positives include: the extreme negativity overseas may be overdone, low stock valuations compared to the US, a historically strong dollar now weakening would be a very positive catalyst for international stocks due to the currency exchange, and historically it will flip flop approximately every ten years. The 10 year-annualized return for the S&P 500 (after the 2000 to 2002 US stock drop, followed by the 2008 financial crisis) resulted in the US having a negative average rate of return over this 10-year period. This doesn’t mean we will repeat the exact same fate but there are early signs of this potential tide turning.
- Bonds should act more like bonds and could provide a nice return / yield and hedge to stocks in 2023. After a historic loss in 2022, bonds have gone from being extremely over-valued and a very poor forward-looking outlook to potentially a strong investment opportunity in just the matter of a year. At current bond prices and now higher yields, core bonds have a very high probability of making a 6-7% annualized return for the next few years. **** However, remember bonds are NOT stocks: Despite them now being more attractive, bonds will most likely not have the ability to recover as quickly and as much as stocks can. So, if the stock market does rebound and continue moving higher, stocks will most likely move your portfolios quicker and higher than bonds will.
What could go wrong?
- Continued aggressive FED rate hikes? It takes time to see the effects of policy and if the FED continues to aggressively hike rates, despite a slowing economy and inflation appearing to moderate, this could cause the market to react negatively.
- Inflation isn’t actually moderating? We have said that inflation will most likely stay higher for longer (for reasons mentioned above) but if it doesn’t continue to moderate, or turns higher, this could be a bad sign for the markets, as this would give the FED fuel to continue with rate hikes and the dreaded stagflation could become a reality (combination of high inflation, slow economic growth, and high unemployment)
- Company earnings are a disaster? As mentioned above, company earnings are the life-blood of the stock market so if company earnings are disastrous and we fall into a fairly steep recession, it is likely for the stock market to also re-price (and go lower).
After 3 negative quarters of performance in 2022 (and for the calendar year), the S&P 500 returned a positive 7.56% in 4th quarter 2022 and has sneakily began the year in 2023, up approximately 4%. After a historic loss in principle in bonds in 2022, 4th quarter was also positive for bonds, up 1.87% and has begun the year up over 3% already in 2023. Time will tell if this will continue , along with likely continued volatility, but hopefully we will see results at the end of 2023 that look much different (and better) than 2022.