In this latest installment of our newsletter, we share our observations on 2022 and our outlook for 2023. Click here to go to the full report on our website. Following are the highlights:
- Good Riddance to 2022!
- Most investors were happy to see 2022 come to an end. There were few places for investors to hide, as nearly every segment of the financial markets posted losses for the year. U.S. stocks posted their worst year since 2008, while many parts of the bond market suffered their biggest losses in history.
- The traditional role of income investments as a buffer to more volatile equity markets did not hold up, deepening the pain of balanced portfolios.
- The S&P 500 posted a negative total return for the year of 18.1%, just shy of bear market territory (a decline of 20% or more), where it had spent much of the year.
- Bonds had their worst year in history, with the Bloomberg Barclay’s Aggregate Bond Index posting a 13% decline for the year. Prior year losses going back to 1976 had never exceeded negative 2% for the bond index.
- Global diversification didn’t help investors either, as both the European and emerging markets indices experienced double-digit losses.
- And in perhaps the most spectacular crash of the year, cryptocurrencies spent most of the year in severe decline, capped off by the collapse of crypto trading platform FTX in November. The largest cryptocurrency, bitcoin, lost over $550 billion in market value in 2022 as its price sank 65%.
- The market’s heightened volatility was directly related to larger-than-expected increases in inflation and interest rates throughout the year.
- U.S. inflation hit a decades-high rate of over 9% in June 2022, spurring the Federal Reserve to raise its benchmark Fed Funds rate at its fastest pace since the early 1980s. The Fed’s seven interest rate hikes through the year resulted in the short-term rate rising sharply to a target range of 4.25% – 4.5% at year-end from near zero in January.
- Looking ahead, the good news is that the worst of the rate hikes is likely behind us, as the Fed is expected to slow its pace of rate increases in 2023. At its next meeting in February, many expect the Fed to raise rates by just 0.25% and end 2023 with an expected Fed Funds rate of around 5%.
- Recession or Slow-cession? Rising interest rates are intended to slow the economy just enough to dampen inflation. But a recent WSJ survey indicated that economists place roughly 65% odds on the U.S. economy slowing enough to fall into some level of recession in 2023. The depth and length of a potential recession, however, remain hotly debated.
- In fact, several economists believe that 2023 might not bring a full-blown recession at all, but rather a “slow-cession” – or a period of less than 1% GDP growth in each of the next four quarters. They point to the strong labor market, healthy consumer and corporate balance sheets, and a well-capitalized financial system as reasons why the U.S. economy could avoid a significant economic contraction this year.
- Declining inflation is another potential bright spot for the U.S. economy in 2023. The Consumer Price Index, or CPI, which is the broadest measure of inflation, hit a highpoint of 9.1% in June 2022 and has since declined steadily to its latest reading of 6.5% in December, which was the smallest 12-month increase since December 2021.
- Outlook for 2023: Our outlook for the stock market and the economy in 2023 is somewhat mixed. While we do expect inflation and interest rates to moderate in 2023, their negative impact on corporate earnings and the job market is likely to become more pronounced in the first part of the year.
- While we are maintaining our long-term, value-oriented investment philosophy, we have taken a more cautious view of equity markets for the near-term. Instead, we have been deploying cash in short-term U.S. Treasuries at attractive, risk-free yields in excess of 4.5%.
- Stock valuations have started 2023 at more reasonable levels than at the beginning of 2022. The forward 12-month price/earnings ratio for the S&P 500 currently stands at 17.3 times, below the 5-year average of 18.3 times and well below the 23x valuation at the beginning of 2022. We believe this should translate into better compounded returns for investors over the next 2 – 5 years once the economy and markets stabilize.
The Edgemoor Team
