Market Commentary: Year-End 2022
At a Glance
- Equity and bonds rallied in the fourth quarter, but it was a challenging year for almost all asset classes
- Energy stocks were a lone bright spot while technology stocks fell sharply
- Inflation may be peaking, but a recession early this year seems likely
- Asset returns in 2023 will be driven by the depth and length of the recession relative to investor’s expectations
(Almost) nowhere to hide
WIth a rally in October and November, stock and bond markets posted a positive fourth quarter after a challenging 2022 for almost all asset classes. The S&P 500 Index rose 7.56% for the quarter, but fell 18.11% for the year.1 Fixed income showed a similar pattern with the US bond aggregate index up 1.64% in Q4 but down 12.03% for the year, not providing the offset that investors count on.2 The drawdowns in both stocks and bonds were driven by the Fed’s sharp interest rate increases, aggressively put in place to combat persistently high inflation, and the risks that the monetary tightening would lead to an economic recession. As the year came to a close, some signs emerged that inflation might be peaking and the Fed would begin to ratchet down the rate hikes in time to head off a severe economic slowdown. Still, a pullback in stocks and bonds in December illustrates that uncertainty on both of these dimensions remains high.
In the equity markets, the winners and losers of both the fourth quarter and the full year remained the same. Value stocks and the old-school, higher dividend paying Dow companies fared best, with the Dow outpacing the growth and tech-heavy NASDAQ by over 25% for the year. International stocks lagged US stocks for most of the year, but a solid rally in Q4 helped close the gap for the full year. Outside the US, beaten down European emerging markets and Chinese stocks rallied most to end the year.3
Equity Total Returns: Q4 and 2022
One of the only places among equities to post positive returns in 2022 was in Energy stocks. The sector jumped just over 20% in the fourth quarter and almost 60% for the full year. Still strong economic activity combined with substantial uncertainty in energy supplies from the war in Ukraine, boosted energy prices in general and oil prices specifically, creating substantial profits for energy companies. Energy prices have come down sharply since their peak in August but remain at high levels relative to history. All other sectors showed negative returns for the full year, but defensive industries (Utilities, Staples, Healthcare) fared best for the year as well as the fourth quarter. Conversely, technology industries (Information Technology and Communications) as well the economically sensitive Consumer Discretionary sector fell close to 40% for the year and did not see a strong bounce in the fourth quarter. The real estate sector also was down sharply as home sales have fallen 37% this year and home prices have steadily declined since peaking in June.7
S&P 500 Economic Sector Total Returns: Q4 and 2022
Aggressive Fed tightening during the year took the target fed funds rate from 0.25% in March to 4.5% currently.9 With rates rising substantially, all but the shortest-term fixed income assets saw sharply negative returns for the year. The trend of rising interest rates reversed modestly in November and early December, with the 10-year treasury rate falling to 3.42% on December 7th.10 That decline boosted fixed income returns across the board during the fourth quarter, especially for longer dated global treasuries and higher-grade corporates, a shift in leadership from the short duration and floating rate instruments which held up best in 2022.11
Fixed Income Returns: Q4 and 2022
What lies ahead?
The challenging environment for most assets this year is the direct result of the Fed’s battle with high inflation and the risk that rising interest rates will cause a recession. Investors saw hopeful signs in the fourth quarter that inflationary pressures may have peaked and, as a result, the Fed’s future interest rate increases may be lower than recent levels. The core personal consumption expenditure index (PCE) was 5.5% higher than a year earlier, down from 6.8% at this year’s peak in June.13 Still, year-over-year inflation remains uncomfortably high and the Fed boosted rates by another 50 basis points at their last meeting of the year.14 In addition to the pace of future Fed rate increases, investors are focused on conditions in the real economy where a still tight labor market (223,000 new jobs and a low 3.5% unemployment rate in December15) and robust consumer spending (+0.1% in November from October16) gives hope that the Fed can engineer a soft-landing, or at least a relatively mild recession.
Less optimistically, the more forward looking US leading economic indicators index continued to fall as the year came to an end. Over the six months ending in November, the index is down 3.7% relative to the previous six months with 9 of the 10 individual indicators falling for the month.17 As a result, the index now projects a recession in the US beginning early this year and lasting through mid-year.18
Given the Fed’s aggressive monetary tightening policy, it should not be surprising that a broad slowdown in economic activity is looming. Indeed, the decline in markets in 2022 reflects that expectation. The question for investors, and the impact on asset class returns going forward, is the depth and length of the slowdown as well as asset class valuation levels. Keeping an eye on indicators of economic weakness, especially consumer spending and corporate earnings, as well as the Fed’s interest rate path for signs of worse than expected results will be the key to anticipating the path ahead for markets. It is also important to remember that markets, especially equity markets, tend to recover before the bottoming of the economy. At this point, it seems likely that the US (and Global) economy will contract early in 2023, but, given the relatively robust state of the labor market and household and corporate balance sheets, any recession may prove short and mild.
The views expressed in this material are the views of Atomi Financial Group, Inc. dba Alternativ Wealth through the period ended December 31, 2022 and are subject to change based on market and other conditions.
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