2022 End of Year Market Review

2022 has been a challenging year to say the least. In looking back to our end of year recap from 2021, I shared thoughts about the potential headwinds we could be facing with the Federal Reserve raising interest rates along with continued high inflation. These two figures have remained the dominant topic in the markets for the better part of this year. Here are some reflections on 2022 and thoughts for 2023.

The Market Fluctuations Began Early in 2022   

Looking back at the end of 2021, the S&P 500 was trading at a P/E Ratio of 24.09x earnings (considered to be overvalued historically). The 25-year average P/E Ratio of the S&P 500 is 16.83x earnings, so there was anticipation that we could see a correction in the market at some point early in 2022. 

Right from the beginning of the trading year we experienced a high amount of market volatility. The S&P 500 started the year down -8.4% in January and February. The economy was showing some mixed signals, so a lot of the conversation was centered around recession vs. correction. Oil prices had increased substantially in the early part of the year, which added to the inflationary pressures.  

How the Markets Related to Employment, Home Sales, and Inflation

Although the first two quarters of the year showed negative GDP growth, the employment market was still relatively strong. The consumer remained fairly stable throughout the year, however there were periods of record low consumer confidence mid-year (according to the University of Michigan Consumer Sentiment Index). 

One of the lowest points in the market for 2022 came at the end of June, which was also the peak of inflation (CPI). The housing market was beginning to slow due to climbing interest rates throughout the year, but the low supply of homes was keeping home values relatively stable even though existing home sales and new home starts were declining.  All of this added up to what was the worst first half of the year in the market since 1970 (over 50 years).

The Federal Reserve Raises Interest Rates to Combat Inflation 

Throughout the duration of the year, the main storyline centered around the Fed and their aggressive approach to raising interest rates steadily in order to combat inflation. To put this in perspective, the effective Fed Funds Rate on January 1, 2022 was .08%, according to the Federal Reserve Bank of NY. As of this writing, this rate has jumped to 4.38%. 

The rapid pace of rate increases led to the inversion of the Treasury Yield Curve (The 2yr Rate being higher than the 10yr Rate). The inversion first happened in March of this year, reversed course back to a normal curve, then inverted again in June and has remained inverted. The inversion of the yield curve has been a leading indicator of recession in the past. 

This rate move has put pressure not only on the stock market, but it has also had a negative impact on the fixed income market. The Bloomberg U.S. Aggregate Bond Index is down -12% YTD (Source: Bloomberg, FactSet) and was down as much as -17% in September of 2022.  In comparison the S&P 500 is also down 17% YTD as of the writing of this article. The only asset class that has positive returns for the year in 2022 were Commodities (mainly due to the rise in oil). This created many short-term challenges for the long-term investor with a diversified portfolio of equity and fixed income positions.  

Looking Ahead to 2023

Heading into 2023 we are expecting the equity markets to remain volatile for the first half of the year. Many economists are predicting recession in the second half of 2023 or early 2024.  

Recession however does not always align with market downturn historically. In the comments following the December Fed Meeting, Chairman Powell stated that there is still work to be done in raising rates to accomplish their goal of reducing inflation back to the normal target. We have recently seen signs of inflation cooling in the data from October and November. This led to an expectation from the market that the Fed would be a little more dovish with their future rate hikes. The recent comments were to the contrary. 

With a potential slowdown in earnings for the first half of the year coupled with the Fed not being as cautious, there is a potential for some pressure in the market for the first half of the year. We do believe that as we approach the top of the current rate cycle we will see both the equity and bonds markets settle in 2023 with an inflection point that will turn the momentum positive. 

As we discuss in our review meetings with our clients, we are in this for the long term and remain very optimistic about the long term potential in the markets. Our goal is always to make sure we are properly allocated to align with the objectives and risk tolerance level that our clients have shared with us. We will continue to focus on finding the best opportunities in the market to achieve those objectives in a strategic fashion while maintaining the ability to be tactical in volatile markets. Don’t hesitate to reach out to us if you have any questions about your portfolio. 

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