The fourth quarter of 2022 brought some relief for the battered equity and fixed income markets across the globe. In the U.S., the S&P 500 Index was up about 7% during the quarter, but still closed the year down nearly 20%. Growth stocks were flat during the quarter and ended the year down over 32%. Somewhat less discouraging data on inflation came in during the quarter showing that while inflation is still quite high, the month over month increases were slowing from the peaks seen earlier in the year. The relief from lower inflation data was partially offset by comments from members of the Federal Reserve Board who were clear in stating that inflation is still a major concern and that they planned to keep raising rates over the next few months and suggested rates would remain at elevated levels throughout 2023 and wouldn’t retreat until 2024. 

While rates are a critical piece of how markets value securities, another critical component is corporate earnings, which are dependent in large part on views of the economy and the economy’s effect on corporate profits over the next few years. While many economists and bankers have been predicting recession or are even convinced that we have been in one, GBP (gross domestic product) numbers have been coming in reasonably strong, suggesting we haven’t been in a recession and any recession that 2023 brings should be a shallow one. As investment strategists like to remind us, the market is forward looking, so investors may not be too concerned about news today, but are thinking about events tomorrow, next month, quarter, year and further out.

In my opinion, opportunities present themselves when issues affecting the short-term are reacted to by market participants as though they will be permanent. Examples of this work both to the downside and upside and overreactions in both directions were evident in the period since Covid hit.  Starting in March 2020, all in-person service companies like restaurants, travel businesses and brick and mortar retailers traded as though bankruptcy was more likely than not. By the end of 2020, all internet retailers (Shopify, Amazon and Chewy), on-line service providers (Teledoc) and stay and work from home service providers (Zoom, Peloton) traded as though their revenue trajectory for the first months of the pandemic would continue forever. Fast forward a couple of years and hotels, restaurants and other sectors hurt by the pandemic are still alive and some even prospering while the beneficiaries of remote everything came back down to earth and are even suffering the effects of building for additional growth (taking on debt and over-hiring) that never came.  Many are down over 90% from their highs.

While growth stock indexes crushed value stock indexes during 2020 and most of 2021, that trend reversed sharply during 2022 resulting in companies considered growth becoming more attractive as valuations plummeted. Even tech stalwarts such as Apple, Microsoft, Google and Amazon were down 30% to 50% in 2022. These are all companies with strong brands, balance sheets and profitability. Their value had been inflated by the tech bubble and the free money (0% interest rates) of 2020 and 2021, but they will be around for a long time and are now much more reasonably priced as we start 2023. Another sector that was down sharply was consume discretionary stocks as high inflation and rising borrowing cost dampened spending.  While markets can always go down, I am much more optimistic entering 2023 than I was entering 2022. Should inflation and employment numbers over the next few months provide investors with the belief that the Fed can slow, stop and then reverse interest rate increases, I think the markets will trend upwards. While I believe the volatility in markets seen since the pandemic will abate somewhat in 2023, geopolitics and other factors could provoke large market movements.

Zooming in for a more granular look, I am reasonably sanguine on certain commodities and have added exposure to them in the last quarter. Commodities and companies extracting them generally performed well in 2022 led by oil and steel companies. That said, silver, copper and lithium which didn’t perform well in 2022 are integral components of the move to green energy which will be accelerating as the funding and credits promised by the Inflation Reduction Act start circulating through the economy. The uptake in electric vehicle batteries, solar panels, wind turbines and battery storage will add demand to already supply-constrained commodities. As you’ve probably gleaned from some of my previous writings, I was likely to be pleased with the intent of the climate portion of the Inflation Reduction Act and hope it can be implemented without excessive fraud or waste.  If you believe climate change contributes to the frequency and intensity of natural disasters, then it will be money well spent.  Losses from domestic weather events cost $165 billion in 2022 (www.climate.gov) including about $112 billion for Hurricane Ian in Florida alone. The average from 2010-2019 was $93.8 billion and from 2000-2009 was $58.7 billion.  The trajectory of these costs is alarming, not to mention the lives lost.

Bond markets also recovered during the fourth quarter of 2022, but even that didn’t prevent bonds from having a historically bad year as increasing rates and the prospect of continued Federal Funds Rate increases drove prices lower. The AGG ETF, which holds investment grade government, agency and corporate debt was down 13% during 2022.  Last year is now in the history books and the good news is that attractive bond yields do exist, especially on shorter duration issues. When short-term bond yields exceed long-term bond yields, it is referred to as an “inverted yield curve”. This is not the norm as you would normally expect higher annualized returns for tying your money up for longer periods of time. The inversion occurs because market participants expect that rates will come down from current levels in future years.  We are now getting nice returns on cash and safe short-term bonds so allocating a reasonable portion of your investment to bonds no longer seems like a losing proposition.

That’s it.  If you made it this far, you should sleep well tonight!  Should you have any questions about the attached report, this email, your portfolio, or anything else related to your financial life, my line is always open.

I wish you, your family and friends a Happy and Healthy New Year.

Best regards,

Steve