I believe it goes without saying that putting 2022 in the rear-view mirror could not have come quick enough. Difficulty in financial markets, the economy as well as geopolitical tensions have weighed heavy on the minds of many over the last 12 months.
The S&P 500 Index was down over 18% and bonds, which typically do well when equities decline, were also down over 12% for the year due mostly to the Federal Reserve hiking interest rates to combat inflation. There were few places to hide from declining asset prices and rising consumer costs in 2022.
Fortunately, inflation as measured by the headline Consumer Price Index (CPI), which peaked at close to 9% year-over-year in June of 2022, has been in a downtrend and finished the year at 6.4%.
Further, these year-over-year CPI figures are somewhat misleading as they still contain the readings for the high inflation months of early last year. This is what is referred to as “base effects” and, as the high inflation months fall off the year-over-year readings, you should expect to see the headline CPI data begin to moderate downward toward the Federal Reserve’s target of around 2%. It should be noted though, that we may not reach the Fed’s desired target until 2024 or later.
Looking forward to 2023, I am somewhat optimistic that stocks and bonds are in a position to recoup some of the losses from 2022. I say this in spite of the fact that I believe we will likely have a recession here in the US in 2023.
First, with the yield on the Bloomberg Barclays US Aggregate Bond Index (the Agg) currently over 4.6% and the Federal Reserve presumably closer to the end of hiking rates, we should be able to generate some decent income on bonds moving forward. As a reference, the yield on the Agg index at the start of last year was 1.75%. Additionally, investors typically move to the relative safety of bonds relative to stocks when the economy softens.
As far as stocks in 2023, we’re off to a decent start, up over 6% year-to-date as of January 30th. While this is welcome news for investors, I believe we will experience some choppiness in the markets for the near-term.
As mentioned previously, inflation appears headed in the right direction and the Fed is closer to the end of rate hikes after raising interest rates a total of 7 times in 2022, but if these don’t continue in the right direction we could see some more volatility and drawdowns in the stock market.
The Fed is also in a precarious position in that they are trying to tame inflation by slowing the economy, but they also run the risk of tightening economic conditions too much and causing a painful recession. As of now, the general market consensus is for a short and shallow recession sometime in 2023, but there is still a risk that if conditions deteriorate faster than the Fed anticipates, we could see something more severe than that consensus scenario.
The good news for stocks though is that they typically bottom and begin to rise before the end of a recession. As forward-looking mechanisms, markets fall in advance of deteriorating economic conditions and begin to rebound once the extent of the economic damage is done. This is also the reason why, historically, the best time(s) to invest have been when the economy feels the worst in real time.
With that said, we don’t attempt to time these inflection points in markets when investing on behalf of our clients. Attempting to do so has proven to be statistically a near impossibility with the risk of hurting investment returns by doing so.
Instead, we stick to our time-tested approach of thoughtfully allocating and diversifying into asset classes and investments with a history of appreciation and a focus on the long-term. We believe this consistent approach gives our advisors the ability to confidently guide our clients to and through retirement.
Here’s to hoping 2023 is a prosperous one!