Quarterly Commentary, Q4 2022

During the fourth quarter of 2022, the markets advanced, with both bonds and stocks having positive results. The Federal Reserve continued to tap the brakes, increasing rates twice—in November for 75 basis points and in December for 50 basis points—while simultaneously reinforcing their plan for additional rate hikes in 2023. Despite the Fed, the markets are starting to respond positively, while the 10-year Treasury yield hit 4.2% during the quarter but is now lower at 3.8%. Equities posted a gain for the quarter but not enough to save the negative year. The CPI inflation rate peaked at 9.0% (year over year) in July, the highest since January 1982, and is down to 7.1% as of November (the latest reading as of January 5). Meanwhile, the Fed is targeting a 2.0% inflation rate. Consensus expectations are for inflation to continue its decline to the 4.0% range by the spring. If this happens, it may be positive for financial assets. 

We may be in a recession or we may be going into a recession. Historically the equity market has bottomed during a recession. In addition, stock valuations, as measured by price-to-earnings ratio, are more attractive now than they’ve been in the last four years, excluding the short six-month Covid-19 sell-off.

There are many positive economic signs. Unemployment is 3.6%, almost the lowest in five decades from a high of 14.7% during Covid in 2020. Commodities and supply chain disruptions, the two most significant contributors to inflation, have peaked and are subsiding. Oil peaked in March 2022 at $123/barrel and is currently at $73/barrel. Household debt payments as a percent of disposable personal income are at some of the lowest levels on record since 1980. Consumer sentiment is also at its lowest since the Global Financial Crisis (mid 2007-early 2009), historically an excellent time to own equities. As Warren Buffett says, “Be fearful when others are greedy and greedy when others are fearful.”

The fixed income markets had a positive quarter thanks to a decrease in longer-term interest rates. Although the year ended as the worst on record for the U.S. investment grade bond market, down 13.0%, far exceeding the next worst year in 1994, a negative 3.1%, as measured by the Bloomberg US Aggregate Bond Index. Your fixed income at Resource Consulting Group with higher quality and shorter duration, fared much better. Furthermore, the higher interest rates of today versus a year ago produce more return (income) from your fixed income allocation.

The S&P 500 finished up 7.6% for the quarter and down 18.1% for the year, the worst year since the Global Financial Crisis. Your equities fared better due to a value tilt. Value investing is based on the premise that paying less for a set of future cash flows is associated with a higher expected return. Over the long term, value has been shown to have lower volatility and better returns than growth investing. 

Meanwhile, Europe’s energy crisis wasn’t as bad as expected, thanks to supplies and weather being better than anticipated. China’s growth should be a positive for the world economy as they end lockdowns and refocus on the economy. Unfortunately, Russia’s war with Ukraine has not yet ended, and it is unknown when there could be a resolution. We know uncertainty is a constant, and risk will ebb and flow with economic events. But inflation is declining, stocks are modestly cheaper than their 25-year historical average, and consensus expectations are for the Fed to end its tightening cycle during 2023. In 2009, shortly following the end of the Global Financial Crisis, the S&P 500 was up 23%. This Dimensional Funds graph shows that annual returns are positive 75% of the time. Staying invested during uncertainty puts you in a good position to reach your long-term investment goals.