Many investors are no doubt glad to see 2022 in the rear-view mirror, and if they do look back, the picture is not pretty. Stocks were buffeted by the Federal Reserve Board's aggressive rate hikes (the fastest since the 1980s stagflation era) and the reverse of the QE policies which, for a decade or more, flooded the markets with liquidity. It didn't help that there were persistent fears of a recession all through the last 12 months, and a certain level of alarm over the Russia-Ukraine war. 2022 saw the three main stock indexes post their first yearly drop since 2018, and market economists with long memories were comparing this perfect storm of headwinds to the declines triggered by the 2008 financial crisis.
A breakdown shows that just about every U.S. investment asset was showing double-digit declines.
Looking at large and mid-cap stocks, the S&P 500 index of large company stocks gained 7.56% during the year’s final quarter and overall finished down 18.11% in calendar 2022. Meanwhile, the S&P MidCap 400 Index finished the 2022 calendar year down 13.06%.
As measured by the S&P SmallCap 600 index, investors in smaller companies received a 9.19% gain for the last quarter but were still down 16.10% for the year. The technology-heavy Nasdaq Composite Index was the biggest loser in 2022, dropping 28.27% of its value over the last 12 months.
The foreign markets were no better. The broad-based EAFE Total Return index of companies in developed foreign economies gained 17.40% in the final quarter of 2022, but still lost 14.01% of its value in dollar terms for the year just ended. In aggregate, European stocks lost 17.28% in 2022, while EAFE’s Far East Index was down 17.20%. Emerging market stocks of less developed countries, as represented by the EAFE EM Total Return index, lost 19.74% in dollar terms in 2022.
Real estate securities produced even greater losses, albeit for small portions of most investment portfolios. The S&P U.S. REIT index posted a 27.04% loss in 2022. However, due to global increases in oil prices, the S&P GSCI index, which measures commodities returns, eked out a 0.38% gain in the 4th quarter, ending the year up 8.71%.
Perhaps the most dramatic market movements in 2022 occurred in the bond markets, where yields on 10-year Treasury bonds rose dramatically over the course of the year, from 0.95% a year ago to 3.87% currently. 30-year government bond yields rose from 1.88% at this time last year to 3.96%. Five-year municipal bonds were providing, on average, a meager 0.60% yield last January; now the rate is a comparatively robust 2.56%, while 30-year munis are yielding 3.63% on average. Of course, for bond investors, these yield increases create negative returns; when rates increase, bond prices decrease. Indeed, the total return for the Bloomberg Aggregate Bond Index was -13.01%, the worst return in at least 50 years since the index’s inception.
The broad market downturn, in stocks and bonds, marks the end of an extraordinary period of investment history, a three-year run that saw many investors at or near doubling their portfolio values. Indeed, the S&P 500 ended 2022 about 18% higher than at the end of 2019, not bad when you consider what our economy has endured over the past 3 years.
What will 2023 bring? Of course, it’s impossible to predict markets even in calm periods, and there seem to be more mixed signals than ever. It's certainly possible that the Fed will achieve that mythical ‘soft landing’ for the economy in the coming year. Inflation seems to have peaked and is falling faster than many expected—the CPI was up just 0.1% in November, 7.1% year-over-year. The GDP, which measures growth in the economy, recovered in the third quarter; total economic activity in the U.S. expanded a healthy 2.9% for the three months ending September 30, and a survey of economists suggests that growth could reach 1.0% in the fourth quarter. Unemployment is still low, at 3.7%. Low unemployment, wage gains, and near 1% gains in personal income are fueling an increase in consumer spending. U.S retail sales posted their strongest gains in eight months this past October.
But… investors may be cautious about feeling too optimistic quite yet, especially with that glimpse into the rear-view mirror. 2022 marks the first year in history when the S&P 500 and 20-year Treasury bonds both experienced double-digit losses; the previous ‘record’ was 1969, when the S&P 500 lost 8.5% and long Treasuries declined by 5.1%. Global diversification also didn’t help, as both the MSCI EAFE and emerging markets experienced double-digit losses.
The problem for the investment markets is that what had been a strong tail wind is now a brisk head wind. The Fed is engaged in quantitative tightening, shrinking its $9 trillion balance sheet by roughly $100 billion per month. As the Fed economists continue to bring inflation down to a 2% annual rate target, they are likely to raise the Fed funds rate to at least 5%, which makes short-term bond instruments competitive with stocks and reduces demand in the equities markets.
Meanwhile, the housing market recently experienced the ninth consecutive month of declining sales—almost certainly due to higher mortgage rates. And the Conference Board’s October index of leading economic indicators recently declined for the eighth straight month, which may signal an increasing risk of a recession in the coming year. That gloomy prediction is reinforced by the inverted yield curve. The recent spread between three-month and 10-year Treasury bonds has reached -0.77%. When investors buy long-term bonds at lower yields than short-term bonds, it means they’re expecting turmoil on the horizon.
When the markets decline as they did this past year, history tells us that they become a buying opportunity; in effect, they go on sale, and become more attractively priced than they were before the downturn. While there is no guarantee that stocks won't become even cheaper in the coming year, we do know is that stocks have always recovered, and we believe they always will. The biggest danger has always been to move to the sidelines at the wrong time and miss out on that next upsurge. As Peter Lynch famously stated, “The real key to making money in stocks is not to get scared out of them.” If we knew any more than that about the future, you would be the first to hear from us.
Wilshire index data: http://www.wilshire.com/Indexes/calculator/
Russell index data: http://www.ftse.com/products/indices/russell-us
Nasdaq index data:
International indices: https://www.msci.com/end-of-day-data-search
Commodities index data:
Treasury market rates: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/
Canopy Commentary - 2022 Market Review
January 12, 2023