First of all, welcome to 2023. We hope this letter finds you and your family doing well. We want to reflect a bit on 2022 and step through some of the nuance that is involved in a projection for 2023. Let’s jump right into it…
Some Perspective on 2022
As we look back at 2022, it’s clear that it was a challenging year for the financial markets. Several years of government spending led to inflation that was well above desired levels. Russia’s war in Ukraine exacerbated the inflation problem by further disrupting the supply chain. In addition, it added to global uncertainty.
As a result, the Federal Reserve had to prioritize the fight against inflation as they set policy – and this led to notable increases in interest rates. Since an interest rate is the “price” to borrow money, it tends to slow economic activity when rates move significantly higher over a short period. We see this higher cost of money affecting a range of decisions. Homebuyers are more hesitant, companies are increasingly cautious when considering projects for 2023, and hiring is slowing.
Here’s a quick look at the performance of some key benchmarks in 2022:
- S&P 500 -19.65%1
- Nasdaq -33.10%2
- EAFE -16.17%3
- 20 Year US Treasury Bond -26.79%4
The S&P500 is comprised of the 500 largest US companies. The Nasdaq is a large benchmark that is heavily weighted towards technology firms. The EAFE Index tracks international developed markets.
Considering that investment results are largely driven and influenced by the benchmarks above, it becomes apparent that viewing 2022 results is not going to be a pleasant experience. This is particularly true when the year is viewed in isolation. With government bonds participating in the selloff, even the most conservative investors were impacted. Bonds typically diversify a portfolio and can often move in the opposite direction as stocks; however, in 2022 both primary asset classes declined.
As investors, we tend to remember the highest points our accounts reach, but it can be useful to widen the lens a bit. Keep in mind that we had three strong years leading into 2022. The market gave back some of the large gains from prior years.
Think of this scenario: if we were offered the results of 2019, 2020, 2021, and 2022 for the next four years would we take it again? Absolutely – over the last four years we have seen meaningful increases across account balances.
With the tough year that we just completed, I wanted to acknowledge it here before moving forward. If you want to connect for an update on your financial situation or our investment approach then we have a few easy ways to get on our calendar. Just let us know. Now, let’s turn our attention to the year ahead.
What’s 2023 Going to Bring Us?
If you turn on the financial news, you will see a range of forecasts for 2023. Some will be overwhelmingly pessimistic while others are too optimistic. The industry will cover the full spectrum with opinions, and in hindsight…someone is going to be right!
We are comfortable speaking candidly with you about market prospects, and the reality at this point in time is that we cannot be sure about the short term market move. We have several indicators that point to an upcoming recession, yet we don’t know if the market has underpriced or overpriced this impact. It’ll depend on the job market, corporate earnings, inflation readings, and a myriad of other variables.
Yet, in the face of uncertainty, we feel quite confident that we are allocated well for this environment. I’ll share a few reasons why.
The chart below tracks consumer sentiment. Notice that if we purchase when everyone is feeling great, then the average return for the S&P500 over the following 12 months has been 4.1%5. If we purchase when sentiment is at a low point, then the average return has been 24.9%5. This chart captures eight peaks and troughs going back to 1971.
Investing in a Bear Market
When the market entered bear market status (defined as a 20% price decline), we were curious to see…if you were to invest on the day the market entered the bear market, what would your return be one year and two years later?
We pulled the data on each bear market since World War 2, and you can see the results for yourself in the chart below. I’ll share a few observations. There have been 12 bear markets prior to this current one. In 9 of those 12, the market was positive one year later. Look through the numbers below and you’ll see that many of the positive returns included large upswings. When you expand the perspective to two years, the numbers are even more attractive.
Of course, I see the three red outcomes as well. This is where we have to admit there is a degree of uncertainty at the moment. As investors, we are choosing to accept the possibility for additional downside. This chart below shows us that further downside occurred 25% of the time, while positive results spanned the remaining 75%. If we’re in the business of making educated allocation decisions, then these are very good odds.
The Elephant in the Room
I can’t wrap up commentary on 2023 without addressing the Federal Reserve. The Fed has two mandates: (1) To maximize employment and (2) To stabilize the US Dollar. The mandates are opposed to each other, so the Fed has to balance economic data to determine the appropriate course of action.
In 2023, this puts us in an interesting place. If weak economic data comes in, then this will give the Fed some room to soften its stance against inflation. We have the potential for weak/bad economic data to be a positive market signal. On the other hand, if we see data indicating economic strength, such as a strong job market, then this may lead to more aggressive Fed action and a negative market reaction.
As I write this note early in 2023, we are seeing clear signs of a softening economy. Take a look at the PMI Chart below. Green indicates growth while yellows/oranges/reds signal a slowdown. This is the type of data that may give the Fed reason to soften its stance.
So, what’s the bottom line?
You can look back through our past articles and you’ll see many where we make predictions, often very specific ones. This particular year I wanted to show you the variety of data we're seeing. It’s clear that the economy is cooler than it was a year ago – but inflation data shows it was too hot back then, so we need to see some cooling.
We work with the largest financial companies in the world to stay on top of data. While the ‘experts’ won’t say it during a public interview, the reality is that we just have to navigate through some uncertainty. We’ll be watching closely and adding tactical moves when opportunities arise.
Perhaps a good comparison would be a pilot coming on to say “Ladies and Gentleman, we expect some turbulence ahead. We can see there are choppy skies. We’ll steer around it as much as possible. Nonetheless, we expect to arrive at your destination at the scheduled time.”
For some of you the ‘destination’ is years away while others have already reached the point that your portfolios are a key component of your income. If you want to revisit your risk/return level, then we are available to do this.
We’ll be monitoring the skies and we’ll have further updates for you as we move ahead.
- Standard & Poor's
- MSCI EAFE Index
- J.P. Morgan Asset Management
The S&P 500 is an unmanaged index comprised of 500 widely-held securities considered to be representative of the stock market in general. You cannot directly invest in the S&P 500 index.
No investment strategy can guarantee a profit or protect against loss.