Even as the United States and the rest of the world began to emerge from the pandemic, 2022 was a rough year for the U.S. economy and for our financial markets. Stocks suffered their worst loss in over a decade with the S&P 500 Index declining 18.11% for the year. Bonds also suffered steep losses as represented by the 13.01% drop in the Bloomberg US Aggregate Index.
High levels of inflation resulting largely from supply chain issues associated with the pandemic, coupled with higher interest rates resulting from the Fed’s efforts to combat inflation led to down years for both stocks and bonds. Add to this concerns about the economic consequences of the war in Ukraine, you had a perfect storm for a down year on all fronts.
In our view, the story of 2022 was mostly about the rapid changes in interest rates that hurt many conservative investors, along with other events such as the War in Ukraine and inflation. The stock market had its troubles as well, but the bond market is where people saw pain for the first time in a very long time.
As far as the stock market, growth-oriented stocks fared far worse than value. The Russell 1000 Growth Index lost 29.14% for the year while the Russell 1000 Value Index was down 7.54% for the year. Many major large technology stocks saw their share price decline markedly in 2022, including:
These and other former high-flyers helped lead major averages like the S&P 500 lower in 2022.
On the value side, energy stocks held up reasonably well, as did some high-profile quality names. For example, Berkshire Hathaway’s A shares were up 4.0% for the year.
Foreign stocks also had a tough time in 2022. The MSCI EAFE was down 14.45% for the year, with the MSCI Emerging Markets Index losing 22.37%.
As we look to the markets for 2023, we are optimistic as far as the stock and bond markets go. We’ve recently seen that the Fed’s efforts in the areas of increased interest rates and monetary tightening have started to pay off in terms of moderating inflation. This is an important factor as inflation hurts bonds and certain types of stocks.
As we always do, we will be evaluating our client investment strategy at an overall level and on a client-by-client basis, as each client’s situation is unique.
We will be looking at recalibrating portfolios for an environment that is potentially past peak inflation levels, where the U.S. dollar has peaked relative to other world currencies, and where long-maturity interest rates have peaked on bonds.
In some cases, we may unwind inflation hedges such as selling commodities, energy stocks, and Treasury Inflation-Protected Securities (TIPS). The degree to which we make these or other adjustments will be reviewed for each client.
As far as stocks, we have a tactical regional preference for international developed markets and emerging market equities. On the bond side, we expect to be a bit overweight in longer-duration bonds. We also expect to increase exposure to credit spreads via the use of mortgage-backed securities and emerging market bonds.
Our expectations for inflation have improved and it’s our belief that the Fed could potentially end rate hikes while real economic growth is still positive in the U.S. As such we will be continuing to realign portfolios to gradually shift risk across both equities and fixed income. This will be based on the continuing improved clarity as to the market and economic conditions we continue to see. This will also be done across each client’s portfolio to align with their unique needs, including their time horizon, risk tolerance, and financial goals.
The confidence to make these moves stems from our belief that inflation has peaked and will likely decelerate at a sufficient pace over the coming months to convince the Fed to pause, and for all practical purposes end, their campaign of interest rate hikes.
If this proves correct, it means the Fed’s hawkish stance, and its adverse influence on markets may have also peaked. Softening U.S. inflation and less Fed-hawkishness may also mean a peak in the strength of the US dollar – which could make overseas assets particularly attractive on a tactical basis. So far in 2023, we have seen a high level of strength in many foreign stock funds, but it is too early to tell if this will last.
The risk of slowing growth or an economic contraction is still substantial, but we don’t think a severe recession is necessarily a foregone conclusion. This is in contrast to the consensus expectation of many professional economists.
In the event that a recession fails to materialize, we see potential upside. Even with a mild recession, we think the potential for substantial further declines in the prices of more risky assets may be limited given the sell-off of 2022.
U.S. corporations and consumers continue to hold relatively high cash balances and moderate debt burdens meaning recession avoidance may not be as improbable as many experts believe.
Our thoughts on the potential for the Fed to ease its harsh regimen of rate hikes and restrictive monetary policy gives us hope that equities could deliver positive returns once again in 2023. On the bond side, we feel this easing in Fed policies, along with potentially lower inflation could help return bonds to their traditional role as a solid portfolio diversifier and an asset class that can help dampen volatility.
Please call us at 518-885-3230 or 239-435-0090 to let us know if you have questions. We welcome clients who are interested in financial planning, opening investment accounts, or adding to existing investment accounts.
Bill Canty, CFP®, CPA
Ed Canty, CFP®, Investment Advisor
Joe Canty, Investment Advisor
Maureen Walsh, EA, Tax Advisor
Tina Alteri, CPA, Tax Advisor