January Market Perspective
2022 was a very rough year for investors worldwide. There were virtually no broad market indices spared from the carnage, including large, mid, and small cap U.S. stocks, foreign stocks, and bonds. To put last year in perspective, looking back 100 years, only in 1931 and 1969 did the U.S. stock and bond markets decline in the same year. Drilling down a little further, since 1926 there were only 37 calendar quarters during which both stocks and bonds declined – less than 10% of the roughly 384 quarters during that time period.
For the year, the Dow lost 8.8% to 33,147, and down 10.3% from its 52-week high. The S&P 500 dropped 19.4% to 3,839, and more than 20% off its record high. The tech-heavy NASDAQ took the brunt of the economic storm tumbling 33.1% for the year, and down almost 34% from its record high.
For the last 21 years, U.S. stock and bond prices have moved in opposite directions (referred to as “negative correlation”) on an annual basis. But 2022 was different, displaying positive correlation between stocks and bonds. For this reason, balanced (diversified) portfolios generally declined more than they would have over the previous 21 years. The broadest measure of U.S bonds, the Bloomberg U.S. Aggregate Bond Index declined 13.01% while the Bloomberg U.S. Corporate Bond Index dropped 15.79%. The worst damage was found in the long-term government bonds, losing 27.09% for the year.
Inflation sparked “the worst defeat for both stocks and bonds in decades,” according to Greg Bassuk, CEO of AXS Investments. “2022 was characterized by an inflation-blindsiding market rout, in part because the year kicked off with Wall Street and Main Street both anticipating a containment on rising prices and a Federal Reserve that would hold interest rates at lower levels. But a fiercely opposite reality endured as inflation skyrocketed.”
Many market analysts have pointed to the Federal Reserve (Fed) as initially acting too slowly in fighting inflation. Early in 2022, when the accelerating inflation reports began to materialize, the Fed was still purchasing bonds (referred to as open market operations) in the open market and adding to the money supply in the economy. The simple definition of inflation is too much money in the economy chasing too few goods and services. Early in the second quarter of 2022, the Fed suddenly reversed course and began selling bonds in an effort to reduce the money supply and raising interest rates at a rapid pace never before seen. The market analysts who previously said the Fed acted too late, now were saying that the Fed was raising interest rates too quickly once it was obvious inflation has gotten out of control.
As we begin 2023, the market is watching every economic report for signs of whether the Fed will continue to raise interest rates. Friday, January 6, was a perfect example. The employment report released that day showed fewer people than expected filed for unemployment benefits, which was good news in and of itself. But the far better news was that the service sector in the economy showed signs of contraction – exactly what the Fed has been waiting for. This ignited a huge rally in the stock market with the Dow climbing more than 700 points, or 2.13%. However, this has been the case for the last several months, that one economic report sets off a market rally only to fizzle in the days or weeks to follow.
If history has shown anything for certain, this market will recover and go on to reach new highs as it always has. The Fed has indicated that it needs to see lower inflation and higher unemployment, especially in the service sector, before it stops raising interest rates. Layoffs, especially in the technology sector, have already begun. For example, Amazon recently announced that it will be laying off 18,000 workers in the weeks to come. As strange as it seems, bad news is good news in the eyes of the Fed.
Looking forward into the new year, we agree with many market analysts that investment portfolio construction in 2023 will look nothing like we have seen before, because the economic landscape is nothing like we have seen before. We are working with our research partners to develop portfolios that best meet our clients’ needs and goals given this market environment. If you have any questions or wish to discuss our investment strategy going forward, please do not hesitate to contact our office. Working together, we will get through this storm and go on to much better times.