Although the fourth quarter of 2022 showed some improvement in markets, the year was not pretty. Stocks were shaken by the Federal Reserve Board’s aggressive rate hikes (the fastest since the 1980s stagflation era) and the reversal of long running Fed Reserve policies, which flooded the markets with liquidity. Markets were also impacted by persistent fears of a recession, and a level of alarm over the Russia-Ukraine war.
2022 saw the three main stock indexes post their first yearly drop since 2018. Some market economists compared this perfect storm of headwinds to the declines triggered by the 2008 financial crisis.
The Federal Reserve has been battling high inflation, which has been driven in part by supply chain issues linked to the Global Pandemic. Until very recently, regions in China responsible for about a quarter of China’s GDP, have been on mandatory lockdown due to a zero-Covid policy.
In 2023 you can expect to hear a lot of news regarding economic recession. Know that a recession isn’t a reason to buy or sell stocks. Markets are forward looking, and by the time you hear news about the economy, the market’s response to it will likely be behind us.
Today’s Economic Perspective
In its efforts to get inflation under control, the Federal Reserve has taken extraordinarily aggressive measures to cool the economy. In fact, the Fed has undertaken one of the most aggressive Fed tightening campaigns in U.S. history.
The Fed is hoping to oversee a “soft landing” for the economy. They hope to get inflation under control without sending the economy into a tailspin. Recently, there has been growing consensus among economists and investors that the Fed’s efforts will indeed produce a soft landing for the economy versus a severe recession.
Mixed economic signals are making it difficult to predict what’s next for the economy. There has been significant good economic news mixed in with the bad.
On the bad news side, the U.S. index of leading economic indicators is signaling recession. Leading economic indicators (LEI) suggest that the Federal Reserve’s monetary tightening is curtailing aspects of economic activity, especially housing.
A second factor suggesting an economic downturn in our future has to do with interest rates. The Fed has increased rates so rapidly that long-term interest rates (like those on a 10-year Treasury) are now lower than short-term interest rates. Historically, when this happens the economy will turn down. Economists see an “inverted yield curve” as a predictor of a potential recession.
However, data is also suggesting the economy has considerable strength. One estimate stemming from the Atlanta Fed’s forecasting is that the seasonally adjusted annual rate of growth in the fourth quarter of 2022 is 3.8% (a strong growth number suggesting momentum in the economy).
In addition, employment and new job formation is strong. America’s job market shows no meaningful sign of slumping despite recession fears. Unemployment remains at historical lows.
Lastly, there is better news on inflation. The supply chain is normalizing, helped in part by the reversal of zero-covid policy in China. It is expected that central banks will slow down the pace of rate hikes.
Today’s Market Perspective
2022 brought a broad market downturn in stocks and bonds. It marks the end of an extraordinary period of investment history. We had a three-year run where many investors significantly increased portfolio values.
Just about every U.S. investment asset was showing double-digit declines. The Wilshire 5000 Total Market Index—the broadest measure of U.S. stocks—gained 7.10% in the 4th quarter but ended the year with a 19.04% loss.
The foreign markets were no better. The broad-based EAFE index of companies in developed foreign economies gained 17.00% in the final quarter of 2022, but still lost 16.79% of its value in dollar terms for the year just ended.
Perhaps the most dramatic market movements in 2022 occurred in the bond markets, where yields rose dramatically over the course of the year. Of course, for bond investors, these yield gains represented losses; when rates go up, the lower-yielding bonds that investors had purchased previously lose value proportionately.
Key factors to pay attention to in 2023 include Fed actions, the impact of China opening up its economy, and energy. Europe in particular had serious energy concerns that have been eased recently by China supply opening and favorable weather conditions.
When the markets decline as they did this past year, history suggests that they become a buying opportunity. But there is no guarantee that stocks won’t become even more attractively priced at some point in the coming year. What we do know is that in virtually every historical time period, stock prices have recovered, usually unexpectedly. The biggest danger has always been to move to the sidelines at the wrong time and miss out on that next upsurge.
Final Thoughts
Investors tend to put a lot of focus and energy on avoiding losses (which historically speaking are likely to be short term). The best way to overcome the feeling of loss aversion is to simply stay invested for a longer period of time.
Remember that the basic concept in investing is that the investor decides to endure price volatility (risk) in exchange for a potentially higher long-term rate of return. There are many investments with lower price volatility than stocks, but not without sacrificing potential return to gain a higher degree of stability.
If you are feeling a nagging sense of disorientation and dread about the world around us, you are not alone. And we recognize that it can be emotionally challenging at times to stay the course with your financial strategy.
Our focus is to help clients achieve their most important goals by participating prudently in risk markets. Our process recognized time as a key factor in investing and integrates goal funding and investment strategy. Our desired outcome is to fund client needs without having to recognize investment losses to do so. At the same time, we strive to allow long term assets to stay invested through different market cycles so as not to experience unnecessary opportunity costs.
