Plum Street Advisors
2022 Q4 Commentary
2022 was a dramatic year in many ways. Russia invaded Ukraine in February, the Supreme Court overturned Roe v. Wade in June, and elections in November unexpectedly led to a split Congress. The dramatic news in financial markets was soaring inflation, and the sharp interest rate increases the Federal Reserve and other central banks instituted to fight it. The good news is the medicine seems to have been effective and inflation is on its way down. The bad news is that the pace and severity of interest rate increases was unexpected and negatively impacted global stock and bond markets. Fortunately, corporate earnings have held up, and as markets saw the light at the end of the tunnel in the fourth quarter, both stocks and bonds saw a bit of a rebound.
In the wider economy, housing will likely be one of the economic sectors that is hardest hit in the coming years. The housing market was overvalued to start with, and although 30-year fixed mortgage prices have fallen off of their peak, rates are still 3% higher than at the start of 2022. Home sales were down 38% on a year-over-year basis and Moody’s is predicting a 10% decline in national house prices over the next two years.
The economy is looking to find a new equilibrium in the new higher inflation, higher rate environment. As we note in the “Looking Ahead” section below, we are likely headed for an economic slowdown in 2023, but that doesn’t necessarily imply further market losses, as markets are forward-looking and have already priced in a degree of slower economic activity.
The S&P 500 index gained 7.6% in the fourth quarter, although it still posted an -18.1% decline for all of 2022. This compares to the 2021 gain of 28.7%. 2022 was a year in which growth and value stocks sharply diverged. Value stocks like Occidental Petroleum and Constellation Energy outperformed while growth stocks like Tesla, Meta, and Amazon fell sharply. The Russell 1000 Growth index fell 29.1% while the Russell 1000 Value Index declined just 7.5% for the year.
International stock returns were strong in the fourth quarter, with developed markets (as measured by the MSCI EAFE Index) jumping 17.3% and emerging markets (as measured by the MSCI Emerging Markets Index) rising 9.7%. International markets gained in local currency terms, as they did in the U.S., but these indexes additionally benefitted from a weakening dollar during the quarter – a reversal from earlier in the year. For the full year, the developed markets outperformed the US with a decline of -14.5%, but emerging markets trailed the US with a loss of -20.1%.
The US Federal Reserve continued raising rates in the fourth quarter, but began to slow the pace as they raised rates by 0.75% in November and 0.50% in December.
After holding rates near zero at the start of the year, the Fed has raised interest rates at an unprecedented speed and the Fed was targeting rates at 4.25% – 4.50% by the end of the year. At the next Fed meeting in February, we will likely see another small increase and it appears that peak federal funds interest rates will end up being in the 5.0% to 5.5% range for 2023 before the Fed winds up its inflation shock therapy.
Rising rates have hurt the prices of existing bonds with lower rates this year, but the expectation that we may be reaching the end of the Fed’s increases helped bond markets in the fourth quarter. The broad Bloomberg US Aggregate Bond Index gained 1.9% in the fourth quarter, while the shorter-term (1-3 year) component of this index gained 0.9%. However, this still means a decline of -13.0% for the broad index and a -3.7% decline for the shorter-term index over the course of all of 2022.
Commodity prices were close to flat during the quarter, with the S&P commodity index gaining just 3.4%. Crude oil prices were also close to even for the quarter, but then declined to start 2023 when concern grew about COVID spreading in China as the country winds down its zero-COVID policy. Surprisingly, oil prices remain lower than before Russia invaded Ukraine. Finally, gold rose 11% during the quarter as the dollar declined in value.
As we forecast in last quarter’s commentary, inflation seems to have peaked, with the highest monthly reading in June of 2022. The fourth quarter showed a continued decline in the US consumer price index.
The biggest question facing markets now is no longer related to inflation, but rather whether the Fed’s accelerated pace of interest rate hikes will result in a severe recession in 2023. We tend to think there is ample opportunity for a softer landing. This might include a mild recession, but core economic data remains robust, and a severe recession seems avoidable.
A conservative approach to investing had advantages in 2022. On the stock side a tilt towards steadier value stocks was particularly helpful. On the bond side, keeping maturities a bit shorter than average and including inflation protected bonds helped reduce losses. Finally, the gold position in our client portfolios offered a rare port in the storm this year, as it was one of the very few asset classes that stayed (slightly) positive this year, other than cash.
A final note: the rapid increase in interest rates has caught many savers unaware. If you still have money in low interest bank accounts, you should be aware that as of this writing, the latest reported average yield on money market funds (according to the SEC) is 4.1%. Rates on similar investments vary widely; according to Bankrate.com, the highest 3-year CD rate is about 4.5%, but the national average 3-year CD rate is just 1.0%. Talk to your advisor about options for your cash holdings to make sure you’re getting a fair rate.