Key Takeaways
- In 2022, inflation reached its highest levels in decades, resulting in higher market volatility, interest rate increases, and price declines across most asset classes.
- Value stocks, international stocks, and short-term bonds helped performance.
- At the end of the year, inflation trended downward, and bond yields were at their highest in years.
- The economy might enter a recession, but this could be a “soft landing” as the labor market appears ready to absorb potential job losses.
2022 Market Summary
The S&P 500 bottomed in October, rebounding in the fourth quarter to finish down 18.1% for the year.
Value stocks were down less, 8.0% in the US and 6.9% in developed international markets, as investors preferred stocks with lower prices relative to fundamentals like earnings, assets, and dividends. Additionally, value portfolios typically held greater weights in energy stocks than growth portfolios, and energy was the best-performing sector. Typically, ML&R portfolios have lower exposure to growth stocks than the broad stock market, a position seeking to improve expected returns based on decades of academic research.
The tech-heavy NASDAQ, largely comprised of growth stocks, was battered down 32.5% for the year, reversing its recent trend of outperforming the global stock market. International stocks also reversed their recent trend, outperforming the S&P 500 and slightly helping diversified investors in a down market.
Bonds had an unprecedented year. When interest rates rise, existing bond prices decline as investors can now purchase new bonds with higher interest rates. The typical benchmark for the bond market finished down 13.0%. This falls into the intermediate-term category. However, short-term bonds are generally less sensitive to interest rates increases, so the short-term bond index finished down 5.5%. The silver lining to higher interest rates – investors are now receiving higher interest payments on bonds than they have in years. This helps with expected returns going forward.
In summary, markets generally declined in 2022, but investors saw a few bright spots in value stocks, international stocks, and short-term bonds.
Managing Emotions and Investing
Nobody knows how investments will perform in 2023, but advisors can help navigate the emotions of investing through an objective lens.
The chart below helps illustrate why investors should avoid letting their feelings drive their investment decisions. Consumer sentiment measures how optimistic consumers are about their finances and the economy. In 2022, we saw consumer sentiment at its lowest recorded levels ever. Does this mean poor returns are ahead? Not historically. Since 1971, the S&P 500 averaged a 24.9% return in the twelve months following a trough in consumer sentiment.
Recession and Inflation Concerns?
The Federal Reserve Bank has a dual mandate, seeking price stability and full employment. With prices increasing, the Fed pumped the brakes on the economy by raising interest rates, causing higher borrowing rates on mortgages and credit cards. Now the Fed is balancing inflation and a potential recession.
Investors should not overreact to recession concerns for three reasons.
First, many of us have witnessed the current “worker shortage.” From an economic perspective, if the economy slows down and workers are laid off, the tight labor market, low unemployment, and high number of job openings could result in a “soft landing” as the workers are redeployed to other companies or segments of the economy.
Second, in terms of portfolio positioning, investors are typically better served by sticking with their investment allocations appropriate for the goals, rebalancing to target weights, and taking advantage of tax-loss harvesting opportunities. If investors overreact to press about a recession, they could get off track and miss a market surge. Perhaps the S&P 500’s bottom in October 2022 means the worst is behind us.
Third, the market typically declines before the official recession announcement and rebounds before the announcement that the recession has ended, because official recessions are calculated retrospectively using old data while the market is forward-looking and incorporates current information into prices. Therefore, a recession can be over before it’s officially announced.
Recession and Inflation Forecasts
We expect better returns in 2023, although volatility is likely to continue as new information related to inflation, interest rates, and the economic slowdown comes to light. Inflation could also increase as China eases COVID-19 restrictions and reopens its economy. However, the latest reports show inflation slowing down, mostly due to decreases in energy and car prices. Additionally, consumers, professional forecasters, and implied inflation rates from securities expect inflation rates to go below 3%.
