Quarterly Update

If the third quarter’s update wasn’t much fun to write, neither was this summary of the worst year for markets since 2008. But let’s push on and review major themes from Q4 and 2022, and the outlook as we roll into the new year.

Here’s a roundup of how major markets performed during Q4 and year-to-date, respectively:

• US Large Cap Stocks: up 7.6%, down 18.2%
• US Small Cap Stocks: up 6.2%, down 20.5%
• US Core Bonds: up 1.6%, down 14%
• Developed Foreign Markets: up 17.7%, down 14.4%
• Emerging Markets: up 10.3%, down 20.6%

Stock and bond markets staged a bit of a comeback during October and November before running out of steam as we closed out the year. Looking at all twelve months, the US stock market as measured by the S&P 500, had two other positive runs, one in March and again in July, but otherwise the mood was decidedly negative and that kept prices volatile all year. According to Bespoke Investment Group, 2022 had a near record number of days when the stock market was down at least 1%. Markets at home and abroad would often open in positive territory only to fall into the close – a tough grind.

Across sectors and looking at the whole year, Communication Services, Consumer Discretionary, and Technology led the way lower, falling by 38%, 36%, and 28%, respectively. Corporate names you know, such as Netflix, Disney, Meta (aka Facebook), Google, Amazon, and Tesla, all pandemic market darlings, turned sour during 2022. And Apple was down a relatively benign 26%, but it’s over $2 trillion size helped pull index performance down. All of the 11 sectors lost ground on the year except for Energy, which was up 62%. Interestingly, most of the worst performing sectors still beat Energy over a three-plus year timeframe, but that’s not much consolation for most investors given the sector makes up only 5% of the S&P 500. As market themes go, “value” finally beat “growth” after many years of being trounced by Big Tech and other growth-oriented stocks. There were few places to hide from volatility throughout the year but being diversified between these two themes helped soften the blow a little.

In a way, the most dramatic developments last year happened in the bond market. While core bonds clawed back some return during Q4, the main bond benchmarks were down from 4% to 40% (that’s not a typo) for the year, with the wide return disparity being due to bond duration, a measure of a bond’s price sensitivity to rising interest rates. Typical bonds in your portfolio are of medium duration and were down about 13% last year. So it helped that we kept our maturities and duration shorter, often below the market average, but there weren’t many places to hide in bonds either. These kinds of returns haven’t been seen in decades and happened quickly, primarily due to news about inflation and the Federal Reserve’s response to it.

After revving up in mid-2021 following a variety of pandemic-related issues, 2022 began with inflation averaging about 7%. By June it had risen to a little over 9% before tapering off to where we started the year, at least through November, according to the Bureau of Labor Statistics. That was a lot of inflation quickly and, arguably, declines from the peak were due to Fed policy decisions from about Spring on. Specifically, the Fed raised its short-term benchmark rate seven times last year, from a level of about 0.25% in March to about 4.5% at year’s end. Each increase was meant to incrementally slow the economy and takes time to do so. The Fed was caught off guard by how fast prices were rising and ramped up its increases and rhetoric. While still historically low in absolute terms, rarely has the Fed raised rates so much so fast. The Fed was and is trying to walk a fine line by slowing the economy enough to bring inflation down while not triggering a recession. So far the inflation part seems to be working but, again according to Bespoke, economic indicators are slowing rapidly. Only time will tell if a so-called soft landing is possible.

These interest rate increases also helped the yield curve, another recession indicator, to invert for much of the year. Inversions occur when investors accept lower returns on longer-term bonds than shorter-term bonds because they feel the short-term is more uncertain. Historically this means a recession is a year or so out, but the record is mixed. As we enter 2023, most analysts expect that we’re either in a recession now or we’ll see one soon with the only questions being how bad it will be, and which sectors of the economy get hit hardest.

Other issues from last year linger and continue to jump between foreground to background. Russia’s ongoing war in Ukraine from last February still roils commodities markets and nobody knows how long it will continue. Pandemic-era supply chain issues helped spur inflation and are largely resolved for some industries while the back-and-forth of China’s zero-Covid policy continues to add uncertainty. Consumers here and abroad are still buying but how long that can last at the current rate is an open question. And Inflation is expected to keep slowing into 2023 as the Fed continues to raise rates, another 0.75% is the current best guess based on its own projections.

But it’s not all doom and gloom. While it’s prudent to expect more volatility in the near-term, stock and bond prices will eventually recover as all this and more gets sorted out – they always have. In the meantime, look to your plans, ask questions, and remind yourself that you’re in it for the long haul. We’re here to help.

Have questions? Ask me. I can help.