2022 has been a challenging year in many ways for investors. It was a difficult year for stocks, with the S&P 500 dropping 27% to hit a low on October 12, 2022. There were three rallies over 10% - yet so far, after each rally, the market has turned down to reach new lows. In the blog below, we will share our recap of the year and our thoughts as we exit 2022.
In this blog, you’ll learn:
- Working off the Excesses
- November Inflation Data
- U.S. Federal Reserve Raises Interest Rates Again
- The Inverted Yield Curve Gets Worse
- Bear Market Rallies
- Where Do We Go From Here?
Working off the Excesses
The S&P 500 had a long bull run from 2009 to 2021, reaching an all-time high of 4,818.62 in November 2021. During that bull run, there were a number of unprecedented stimulus actions:
- Quantitative Easing from 2008 until 2022 (U.S. Federal Reserve buying bonds to push money into the economy) through a variety of programs
- Large tax cut in 2017 when the economy was already strong (historically tax cuts were done during weak times to stimulate the economy)
- $5 trillion bond increase on the U.S. Federal Reserve balance sheet during the pandemic
- $5 trillion in assistance programs by the U.S. Federal Government for individuals, companies, state, and local governments during the pandemic
- $1.5 trillion in cash of the government stimulus was given directly to people during the pandemic
The result has been a stock market that has gone up steeply in the past few years.
Source: Hidden Levers
We think 2022 and next year, in 2023, will be the time when the economy and stock market shake out the excesses and revert to longer term growth trend lines.
November Inflation Data
In December 2022, the Bureau of Labor Statistics released the Consumer Price Index for November 2022.
Source: Bureau of Labor Statistics1
Over the last 12 months, the “All Items” index increased by 7.1%, before seasonal adjustment. That is a decrease from 7.7% the prior month. Falling energy prices were a big contributor to the decease of the “All Items” number.
The “All items less food and energy” has fallen back to the levels in January 2022, so it is unchanged during 2022. The Federal Reserve has stated that their target is to get inflation down to 2%. There is still a long way to go to get to that level.
U.S. Federal Reserve Raises Interest Rates Again
On December 14, Federal Reserve Chairman Jerome Powell, announced at his press conference that the Fed Funds Rate would be raised by 0.50% to 4.25%. This is what was expected by analysts.
What was new in the press conference with Chairman Powell was his comments that the Fed expects the top interest rate to be at 5% or just above, which is higher than was expected going into the meeting. He also stated that the Fed expects to keep interest rates high through 2023. Some analysts had expected the Fed to begin lowering interest rates in the later part of 2023. These comments resulted in a selloff in the markets after these announcements.
The Inverted Yield Curve Gets Worse
A reliable indicator of a pending recession has been the inverted yield curve which is calculated by subtracting the interest rate of the 2-year U.S. Treasuries from 10-year Treasuries.
During normal economic conditions, 10-year Treasuries pay a higher interest rate than a 2-year Treasury. This makes sense because investors normally expect to be paid a higher rate of return when they commit their money for a longer period, in a longer-term bond.
Looking over the past 40 years, the yield curve has been inverted in each year prior to a recession. Recessions are shown in gray in the graph below. This yield curve is the most it has been inverted in over 40 years.
Source: Hidden Levers
Many economists and investment firms are now calling for a recession in 2023:
Over two thirds of economists believe a recession is likely to hit in 2023 – Fortune, 6/13/222
Economists Now Expect a Recession, Job Losses by Next Year – WSJ, 10/16/20223
JPMorgan Forecasts “Mild Recession in 2023 – Forbes, November 17, 20224
A recession is foretold; central banks are on course to overtighten policy as they seek to tame inflation – BlackRock, December 20225
Recession in 2023 is now Vanguard’s base case – Market Perspectives: December 20226
If the US has a recession in 2023, we are monitoring signs to see if it will be a mild or a moderate recession. The depth of a recession could have a significant impact on the U.S. stock market. We don’t think a recession is fully priced into the U.S. stock market, so we think a recession in 2023 will put additional downward pressure on stocks.
Bear Market Rallies
A common feature of a bear market are rallies that can be surprisingly strong.
Source: Hidden Levers
The S&P 500 dropped 27% during 2022, to reach the low on October 12. There were 3 significant rallies in the S&P 500 this year, 11% in March, 17% in June, July and August, and 15% in October, November and December.
Volatility has been high, with the market moving up and down as much as 6-8% in a day. We think that in spite of the recent rally in October and November, the downtrend is still intact and if we get a recession in 2023, the market could continue lower early next year.
Where Do We Go From Here?
We remain defensive with client portfolios, since we think there is a high possibility of recession in 2023 and that could drive the U.S. stock market lower. A bear market is not a buy and hold kind of a market. But there are still opportunities, and we will make tactical moves to buy and sell where we see opportunities.
We have started buying bond funds for clients for the first time in almost a year. We plan to continue dollar cost averaging into bond funds over the next few months. The great news is the higher interest rates are providing higher yields in bond funds, which increases their return for investors.
We are getting closer to the end of this bear market. The valuation of stocks is becoming more attractive, with the stock prices of some of the largest companies in America down 50% or more. In some years, there is a stock market rally in December, called the Santa Claus rally. We hope Santa Claus has a gift (a rally) for the stock market this year. 😊
We have been in the financial business during the bear markets from the Dot Com Bust in 2000-2002, Global Financial Crisis in 2007-2007 and Global Pandemic in 2020. This experience has been extremely valuable to help us guide our clients through these challenging markets, and we know from experience, that these challenging markets also present opportunities. We think there will be some excellent investing opportunities in 2023 and we will be watching daily for them.
If you have questions on how the topics in this article could impact your portfolio, give your Wealth Manager a call.
Financial Journey Partners - Partners in Your Financial Journey®
Our Financial Journey Partners office is based in San Jose, California. We have clients that live in many states across the country. If you have questions about your investments or financial situation, call us to schedule time to talk about your specific situation.
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1 US Department of Labor – Consumer Price Index
3 Wall Street Journal - Economists Now Expect a Recession, Job Losses by Next Year
5 BlackRock – 2023 Global Outlook
6 Vanguard – Market perspectives: December 2022