5 Key Insights to Guide Investors in 2023

A little less than 3 years ago, I sat down and wrote “Today’s Marathon: What a Marathon Taught me about a Pandemic”. We were deep into COVID fears and far from seeing the end of what we knew would be an exceptionally difficult journey. As I wrote, I mapped out the things that I thought were still to come – the things that still gave me hope.

I’ve been back in that Marathon mindset again. Physically and socially, the things I hoped for that March have happened, but economically, we are still in that marathon. 

Much of what drove markets in 2022 was the result of the pandemic. The sudden drop and resurgence in business and consumer demand, fiscal and monetary stimulus, and global supply chain capacity created shock waves across the financial system.

The ensuing inflation has become what I hope is our mile 26 of a 3-year market event.

During 2022, markets fell into bear market territory and experienced the worst annual performance since 2008. The stock market, as represented by the MSCI ACWI world stock index, retreated -18.36% during 2022 despite a positive 9.76% fourth quarter. The S&P 500 index did slightly better with year-to-date performance of -18.11%.

The Bloomberg Global Aggregate, a diversified world bond index, was down -16.25% during 2022. The Bloomberg US Aggregate performed better but still retreated -13.01% year-to-date. Of note, both of these bond indexes also had positive Q4 results of 4.55% and 1.87% respectively.

Below, we review five insights from the past year that can help investors to maintain a proper long-term perspective in 2023.

1. The historic surge in interest rates impacted both stocks and bonds

Beneath all of the headlines and day-to-day market noise, one key factor drove markets: the surge in interest rates broke their 40-year declining trend. Since the late 1980s, falling rates have helped to boost both stock and bond prices. Over the past year, the jump in inflation pushed nominal rates higher and forced the Fed to hike policy rates. This led to declines across asset classes at the same time.

While this created challenges for risk focused portfolio’s last year, there is also reason for optimism. Most inflation measures are showing signs of easing, even if they are still elevated. While still highly uncertain, most economists expect inflation and rates to stabilize over the next year rather than repeat the patterns of 2022.

As we look to 2023, we enter with a much better opportunity for yield on lower risk bond assets. Dropping interest rates over the last decade have pushed investors towards riskier stock assets, but the new yield environment suggests that bonds can offer attractive opportunity to the right client.

2. The Fed raised rates at a historically fast pace

The Fed hiked rates across seven consecutive meetings in 2022 including four 75 basis point hikes in a row. At a range of 4.25% to 4.50%, the fed funds rate is now the highest since the housing bubble prior to 2008. In its communication, the Fed has remained committed to raising rates further and keeping them higher for longer in order to fight inflation.

Current market-based measures suggest that the Fed could push policy rates to 5% by mid-2023. The central bank continues to face a balancing act between inflation and a possible recession. Some forecasters expect the U.S. and many other countries to experience a recession in 2023, although most also expect it to be shallow.

Slowing growth may mean that the Fed takes its foot off the brake pedal sooner. If the interest rate peaks during 2023, the short-term headwinds that we have experienced this year may give way to additional opportunity.

We saw the hope/opportunity that a slowing rate increase creates as markets rallied from June to August and again in October and November on the belief that the Fed might begin loosening policy. When these hopes were dashed, markets promptly reversed, causing several back-and-forth swings during the year. These episodes show that good news that is supported by data can be priced in quickly.

3. Inflation reached 40-year highs but is receding

While inflation has not been “transitory” (as expected at the beginning of 2022), it may still be “episodic.” This is because the factors that drove these financial shocks were, for the most part, one-time events. Many of these are already fading as supply chains have improved, energy prices have fallen, and rents have eased. Still, the labor market remains extremely tight and wage pressures could fuel prices that remain higher for longer.

At this point, the direction of inflation may matter to markets more than the level. Investors have been eager to see signs of improvement across both headline and core inflation measures, and good news has been priced in rapidly. There are reasons to expect better inflation numbers over the course of 2023.

4. The rallies in tech, growth and pandemic-era stocks have reversed

The past year also experienced a reversal of the rallies in 2020 and 2021 that were concentrated in the tech sector, Growth style, and pandemic-era stocks. For the first time in years, Value outperformed Growth as former high-flying parts of the market crashed back to Earth. As the economy slowed, interest rates jumped, and Growth was no longer the driver.

As we look toward 2023, we emphasize that diversifying across all parts of the market is important. This includes different size categories (large and small caps), styles (Value and Growth), geographies (U.S., developed markets and emerging markets), sectors, and more.

5. History shows that bear markets eventually recover

While 2022 was challenging, history shows that markets can turn around when investors least expect it. While it can take two years for the average bear market to fully recover, it’s difficult (if not impossible) to predict when the inflection point will occur.

2022 was a marathon, but our focus on the financial success of our clients has remained steadfast. We remain dedicated to our investment discipline which values diversification, risk management, and trusting the cyclicality of the economic cycle over the long-term.

 

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