Capital markets around the world suffered losses in 2022. Stocks and bonds, in the U.S. and abroad, were lower for the year. Indeed, most “risk assets” were lower, from stocks to real estate to cryptocurrencies. The 18% decline in the S&P 500 was the worst calendar year for the U.S. stock market since 2008. (International stocks fared relatively better, down 14%.) For those with balanced accounts, bonds failed to offer their usual ballast, with the 10-year Treasury down 16% and the Barclays Aggregate Bond Index down 12%. For some perspective as to how rare that is, the last time the major stock and bond indices were down in the same year was 1969.
Looking at our portfolio performance, there were some notable bright spots. We were aided by the relative performance of value vs. growth. Most of our stock and bond funds outperformed their respective benchmarks. And, as mentioned, international stocks did better than U.S. stocks. Some of our individual investments turned in disappointing results for the year, but in the aggregate, our portfolios outperformed the market. As we’ve written in the past, small advantages in down markets can add meaningfully to results over time.
The culprit behind the decline in asset values last year is apparent – rising interest rates against a backdrop of higher inflation. And the outlook for the year ahead is likely to be determined by the interest rates and inflation environment as well.
That said, looking forward, we see reasons to be optimistic. For one thing, as interest rates rise and price-to-earnings multiples compress, expected future returns rise. Further, strictly from a historical perspective, back-to-back years with market losses are infrequent. The S&P 500 has been down consecutive years on two occasions since World War 2: 1973-74 and 2000-02. As for bonds, prior to 2021-22, you’d have to go back to 1958-59 to find consecutive down years. And stocks and bonds falling together? Well, it’s never happened in consecutive years. So, the odds are favorable that we could enjoy better returns in 2023.
The greatest risk to our optimism is that the planned interest rate hikes fail to curb inflation and the Fed is forced to go much higher than currently anticipated. We think this is unlikely, as there are already signs that inflation may be easing. We expect that inflation will peak and the Fed will signal a pause in its campaign of rate hikes. If the economy remains strong, rates will probably stay higher for longer. If the economy falls into recession (which, by the way, we think is the lesser of two evils vis-à-vis inflation), the Fed will probably have to start lowering rates again. But either way, we think the end of interest rate increases and the easing of inflation will prove to be positive catalysts for the market.
As a final note, it is worth mentioning that there were several fund distributions at the end of the year, and we were actively harvesting tax losses where appropriate to offset the tax implications of any realized capital gains or distributions. So, you may see an above-average level of activity and higher-than-normal cash balances at year-end. Rest assured we will be re-allocating your capital as appropriate. And as always, please inform us of any changes to your address, phone number or email, any change of circumstances, or any necessary updates to your beneficiaries.
Eddie Carlisle Doug Muenzenmay Julius Ridgway
SoundPath Investment Advisors