January 5, 2023 The fourth quarter brought some relief to stocks and bonds with the S&P 500 rising 7% and the Aggregate Bond Index rising 1.6%, reducing the loss for 2022 to -19% for the S&P 500 and to -13% for the Aggregate Bond Index. The Ten-Year US Treasury Note lost -16% and the 30 Year Treasury Bond lost 33% making this the worst year in the bond market in the last 50 years. Bond market losses made a painful year in the equity markets feel even worse. More to come on the bond market as well as the Federal reserve.
Unlike other equity markets, growth stocks as measured by the NASDAQ Index, lost ground in the fourth quarter ending the year down -33%. Foreign Developed Market stocks were down -14% measured by the EAFE Index. These relatively muted losses were due to a combination of less “growthy” investments (ie: more value) and a reversal in the dollar index. The Emerging Markets Index and the Russell 2000 small stock Index each lost 21% for the year. Perhaps somewhat surprising and admittedly providing little consolation, these levels of equity market losses are rather normal in market selloffs.
Somewhat abnormal, there were few places to hide from losses in 2022. Oil and natural resources were one bright spot but who could have predicted the Russian invasion of the Ukraine. Possibly the best news of the quarter was China’s decision to reopen its economy after a long Covid lockdown. Their reopening should ease supply chain challengers ultimately reducing the inflationary impact of goods shortages and help revive Global GDP, but this will all take time.
So, what are we looking at for 2023? The Federal Reserve has not finished their tightening cycle. They have stated that they may increase rates three more times in early 2023 and then wait and see if inflation continues to ease towards their 2% target. These moves would likely take the Fed Funds rate into the 5.0% range. Many economists believe that will cause the economy to slow and inflation to fall. The effects of Fed interest rate tightening may have already been seen as inflation in November declined
to 7.1% down from a peak of 9.1%. While certainly moving in the right direction, inflation still has a way to go should the Fed stick to its 2% target.
From here, inflation can do one of three things: continue to fall, level off or reverse and increase. If inflation continues to fall, we may see a pause in further Fed rate increases. Leveling off or a reversal in inflation could cause the Fed to increase their rate
tightening even more aggressively. Unfortunately, the Fed is limited in its tools to combat inflation. These tools are also rather blunt and imprecise instruments.
Increased cost of debt (and our government has a bunch), slowing the economy so much as to push us into recession and causing too much pain on the job market are all factors for the Fed to consider as they attempt to navigate us towards a “soft landing”.
For companies, it seems likely that corporate earnings will decrease in 2023 and stock prices may suffer further declines. Companies are beginning to announce layoffs but, at the moment, those companies seem to be concentrated in industries that may have
expanded too quickly. The year-end JOLTS report showed there were 1.7 jobs open for every person unemployed. While we are not sure that “unemployed” equates to “looking for a job”, that statistic is far from recessionary. “Voluntary Quits” or the less delicate version “take this job and shove it” coined by the largely unappreciated economic prognosticator, Johnny Paycheck, have started declining ever so slightly. The recent challenge of companies struggling to find employees may be in its last innings.
At this time, we believe that it is best to take the Fed’s word for it and assume they will follow the inflation fighting path. It remains to be seen if they have gone far enough with their tightening or if they have gone too far. People generally believe that increases in
interest rates hit the economy immediately like they tend to do with the stock and bond markets. However, economists generally believe it can take 6 months for a rate increase to begin affecting the economy with its full effect not realized for 18 months. As always, there will be more to come...
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