Happy New Year!
Much will be written, studied, and argued in the history books looking back on the past 3 years: a global pandemic that saw the world spend the better part of 2020 completely shut down with unemployment hitting 27%, massive amounts of money distributed to pretty much anyone & everyone, and an economy & stock market that defied all the odds to create new highs. But the party ended Jan 3, 2022, as the stock market went on to have its worst year since 2008. (The 7th worst calendar year on record). I would sum up 2022 as the Year of Volatility as the S&P 500 had nearly 120 daily swings of +/-1%. That’s only happened 1 other time in the past 50 years.
Fortunately, bonds are there to help soften the years when stocks stumbled, right? Normally yes, but not in 2022, where bonds had their worst year since 1975, ending down -13%.
This was only the 5th time since 1928 that BOTH stocks and Treasury bonds declined at the same time.
So, what worked? Frankly, not much. Energy and commodities were the clear winners if you were lucky enough to have picked those. I say lucky because as you can see from the following chart showing the past decade’s winners & losers, commodities rarely are the top-performing asset class. In fact, even with last year’s massive +70% return on energy stocks, the 10yr return on energy has only been 5.5%. (As measured by the Vanguard Energy ETF – VDE). Value & defensive stocks fared significantly better than growth stocks last year; Small & Mid-cap stocks held up better than Large Caps. And lastly, Real Estate and Gold didn’t act as the hedge one would typically think.
In looking back at 2022, I think two things really surprised us:
- While most people expected the FED to raise interest rates to battle inflation, I think it was the sheer size and speed at which the FED hiked those rates that caught so many off guard. This was the primary reason bonds fell so hard and most growth asset classes declined so sharply.
- International Markets trailed US markets noticeably for most of the year. China was still completely shut down due to COVID lockdowns; add in Russia’s war with Ukraine & the implications that has on agriculture & oil, and we just didn’t want to own much in the way of international stocks. What we didn’t expect to see was the rapid decline in the US Dollar in 4th quarter that propelled international markets to end the year actually out-performing US equities! (By outperform, we mean “lost less”).
So, let’s add some perspective to this and what it means for serious, long-term investors. As we’ve said in past commentaries and will continue to do so: Bear Markets are never fun to go through and on average decline -33% over 13 months whereas Bull Markets have returned +152% and typically last 3-5 years. That’s still a good trade-off for long-term investors with more than a 5-year time horizon. Take the S&P 500 for example, even after factoring in the -19% decline last year, the 5-year return for the S&P 500 is still around 9%. That’s pretty good in our book.
Here are some things we’re watching as we enter 2023:
- We expect the markets to have continued volatility for the first half of 2023 as they look for the FED to stop raising rates. We are maintaining our tilt toward core stocks, value, dividends & quality over growth for the near term. We do expect this to begin to shift back toward growth at some point mid-year as valuations have come down and are more attractive than they have been in some time. (Small & mid-caps specifically have the best valuations than they’ve had in decades).
- While the FED will most likely continue smaller 0.25 – 0.50% rate hikes the first quarter or two, we do think the 10yr Treasury bond and Dollar have most likely peaked. We underweighted bonds early last year as the rates simply weren’t attractive at 1.25%. Today, however, bonds are easily yielding 5-5.5% and are down in value. This makes for an attractive place to pick up yield. At some point, the FED will pause the rate hikes and then pivot to reduce rates. We think the street is too optimistic in thinking rates start to decrease later this year, but we do think rates start to decrease in 2024. Either way, this should bode well for bonds longer term.
- Inflation was all the focus of last year, peaking at 9% before declining to 7.1% at our last reading in November. We expect inflation to continue to trend lower throughout 2023 and wouldn’t be surprised to see 3% by year-end.
- The economy is surprisingly strong right now. 3rd Qtr GDP was 3.2% and Unemployment is at 3.7%. People are still spending money, shopping, traveling (just ask Southwest airlines last week), etc. That said, the rate hikes are starting to become a factor (i.e. mortgages, housing is already in a recession, layoffs are now trickling in, etc.) That trend will continue throughout the year. We expect the headline conversation to shift from Inflation to Lower Corporate Earnings which are expected to decline substantially as the economy continues to stall. Our official call is for a mild/short recession 2nd qtr through the latter half of the year. That may sound pessimistic but remember the markets are forward-looking and much of that is most likely already priced into this current Bear Market.
Finally, if you bought I-Bonds last year, don’t forget that you can now purchase another round of $10,000 per SS#. The rate has declined from what it was but is still an impressive 6.89%.
Here’s your Useless Fact of the Month:
In 1966 Fredric Baur came up with the idea to stack potato chips into a can instead of simply throwing them into a bag. Proctor & Gamble would go on to sell them as Pringles. Fredric eventually died at age 89 and his final burial wish was to be cremated and placed into (you know where this is headed…) a Pringles can. So, as any good family would do, his children stopped at Walgreens on the way to the funeral and purchased a can of Pringles to put dad’s ashes in. What flavor did they choose for dad? Original flavor, of course. (Obviously, they weren’t from the south, or they would’ve chosen Ranch flavored).
Here’s to wishing you & your family a happy, healthy, & prosperous 2023!
Sean & John