Hello, and happy 2023! We don’t know about you, but we were thrilled to turn the calendar to a new year. 2022 marked one of the most challenging years for investors in recent memory. It was the only time in history where stocks and bonds each fell by more than 10%. The S&P 500 declined 19% and the Aggregate Bond Index dropped 13%, marking its worst year since the inception of the index in 1976. The Nasdaq Index, often synonymous with technology stocks, declined 32.5%. Additionally, real estate, gold, and even bonds aimed at protecting against inflation (known as Treasury Inflation-Protection Securities or TIPS) produced negative returns, along with cryptocurrencies.
Inflation and the Federal Reserve’s aggressive response and policy pivot to increasing interest rates were mostly responsible for the market’s reaction. While the Fed had previously considered inflation “transitory”, they switched their narrative last year to one committed to taming the inflation beast, irrespective of the economic cost. In 2022, the Fed raised interest rates seven times from 0% to over 4% in merely 10 months – one of the swiftest and sharpest rate tightening cycles in decades, and they don’t appear to be done. The good news is with several months of easing inflation numbers, the Fed appears to be winning the war. The challenge: inflation is easing just as leading economic indicators point to a substantial economic slowing ahead.
Driven by progressively tighter monetary policy, many leading economic indicators have decelerated rapidly, pointing to tougher conditions ahead for both consumers and businesses in 2023.
For stocks, earnings estimates have declined, but will likely have to decrease more if the economy falls into recession this year. Even if we avoid a recession, corporate profit growth will likely slow in 2023. The good news is that given the weakness in both stocks and bonds, valuations (or how expensive these assets are) have come off their highs and suggest that some economic weakening is already baked into prices. Additionally, yields are much more attractive, with the yield on the Bloomberg Aggregate Bond Index at 4.26% now versus 1.76% a year ago.
This is our friendly reminder that the economy can never be consistently forecast, nor the market consistently timed. Markets are forward-looking and will likely bottom before the worst of the economic news is over. Turbulence, like bear markets, often ends well before the pilot signals it’s safe to move about the cabin. We believe the most reliable way to capture the full return of stocks and bonds is to ride out their frequent but historically always temporary declines. We are investing in successful companies – businesses that are now refining their strategies opportunistically to meet the needs and wants of their customers. As Warren Buffett said, “For 240 years it’s been a terrible mistake to bet against America”. We agree with Mr. Buffett.
As we always say - but can never say enough - thank you for allowing us to be of service. It is a genuine pleasure and privilege to work with you and your family in the achievement of your goals.
Anne & Anne-Marie
Sources: Kestra Investment Management, AssetMark