Market Perspectives – Market Review: Investing in Downturns
Market Perspectives – Market Review: Investing in Downturns
- December closed out a down year for global markets as interest rates soared.
- The story of 2022 was the rapid rise of inflation and the Federal Reserve (the “Fed”) policy shift from dovish to hawkish as a response.
- The dramatic monetary shifts around the world negatively impacted most asset classes, particularly bonds.
- As we noted last month, slower economic growth is beginning to occur, with many economists expecting a recession. For equity markets, recessions often portend long-term opportunity for patient investors. For fixed income securities, the extremely low-yield environment of recent years appears to have come to a close, at least for now.
“Throughout all my years of investing I’ve found that the big money was never made in the buying or the selling. The big money was made in the waiting.”
– Jessie Livermore, Famed Pioneer of Trading
- After three consecutive quarters of declines in stocks and bonds, the fourth quarter of 2022 saw a reversal as most asset classes advanced. However, fourth quarter returns provided very little solace as the S&P 500 closed the year down 19%, the worst year since the Great Financial Crisis in 2008. The Bloomberg/Barclay’s Aggregate Bond index (the S&P 500 equivalent to the bond market) was down 13% for the year, which is one of the worst years on record for this index. The technology company-heavy NASDAQ was down 33%. This was the first time since World War II that both stocks and bonds were down double digits.
- The abysmal returns must be put into a full monetary cycle context that started after the bear market in the 4th quarter of 2018. The Fed was in their third year of increasing interest rates. A trade war with China was feared to have too large of a negative impact on economic growth. It was at this point the Fed decided to pivot monetary policy, effectively ending their rate increases.
- The stock and bond market responded positively to the new dovish regime in the first half of 2019. When the pandemic began in 2020, the Fed quickly lowered interest rates to zero, and poured trillions of dollars into the economic system.
- The excesses that were born from this glut of monetary stimulus were eye popping (e.g., performance of tech stocks, meme stocks, cryptocurrencies, non-fungible tokens, real estate prices, SPACs, unicorn companies, etc.). Subsequently, 2022 ushered in the other side of the stimulus cycle as inflation finally reared its ugly head. The Fed responded abruptly by increasing interest rates by more than 4% and selling off securities held on their balance sheet (the most restrictive policy stance since the early 1980’s). The inflation fight is still ongoing as 2023 opens. Progress has been made, however, and market participants remain optimistic that the economy will not see 1970's style ongoing inflation, eventually allowing the Fed to ease off the hawkish policy regime.
Equity Market Update
Despite a more positive fourth quarter, 2022 was a year to forget, with all major equity segments posting negative returns, following strong 2021 performance.
Pundits and investors sometimes rely on rules of thumb claimed to be backed by historical evidence, when in fact many of the “heuristics” simply are not factually correct.
- “January Barometer” refers to the belief held by some traders that the investment performance of the S&P 500 in January can predict market performance for the rest of the year. Since 1990 there is little statistical evidence that the S&P 500’s return in January is any more of an accurate predictor than the return in any other month. In fact, since 1990, the month of January has been less correlated with similar returns than all other months except for August.
- “January Effect” refers to the belief that stocks should see a boost to start the new year as “new” retirement plan contributions and repurchases of year-end tax loss-harvesting should provide better market returns in January then in December. Since 1990, the month of January has been positive 16 times and the month of December has been positive 22 times.
Source: YCharts 12/31/2022
Returns Following Declines
If it were possible to select market troughs (which it is not), returns one year later have been stellar on average since 1980. However, the mantra of buying “low,” or when stocks have been hit hardest, has proven rewarding over time.
S&P 500 Returns & Intra Year Decline
Equity markets often experience volatility throughout the year, as represented by the red dots below. The blue bars, which show year end performance, generally show meaningful recoveries.
Bond Market Update
The fixed income markets have fared poorly as well with a large drawdown for bonds, particularly those with longer duration. Longer-dated treasury bonds fell over 30% on the year.
Treasury Curve 2022 vs. 2021
Over the last year, interest rates across all maturities have moved significantly higher, with shorter-term rates moving far more than longer-term rates. In general, this has created a more attractive yield environment for investors following many years of extremely low rates.
Interest Rate Credit Spreads Widen
Interest rates for riskier bonds increased modestly over comparable “safer” treasuries in the last 12 months, as a generally weaker economic environment is expected.
Mortgage Rates at Levels Not Seen Since Before 2005
Higher mortgage rates are already impacting the housing market. Affordability becomes more challenging as higher debt service costs take hold.
Fed Funds Futures Market Expectations
While Fed Funds futures imply further rate hikes are coming, markets are projecting an end to the hiking cycle in the first half of 2023. If these projections prove accurate, fixed income markets may begin to stabilize.
Valuations Have Dropped to Levels Below 20-Year Averages
Average P/E multiples, a commonly used method to value companies, are now below average in many areas of the market. From December 2021 to December 2022, P/E multiples have fallen dramatically when compared to their 20-year averages.
*Source: JP Morgan Guide to the Markets 12/31/22 and 12/31/21
The U.S. Dollar is at Multi-Decade Highs vs. Peers
The restrictive actions of the Fed vs. central banks around the world are strengthening the U.S. dollar and challenging U.S.-based multi-national corporate profits. Additionally, this can be a boon for U.S. consumers, as a stronger currency enables consumers to purchase more foreign goods. The recent pullback and potential for stabilization is a welcome sign.
Bond Market Yields
Dramatic rate increases have led to more attractive yields for fixed income investors.
The arrival of 2023 is a welcome sight for weary investors following one of the worst periods across asset classes in many years. The dramatic pullback in prices in financial markets is in part a function of the highly inflationary environment and Central Bank policy to fight it.
Maintaining a disciplined focus on the long term has generally proven to be the most effective long-term solution compared to relying on heuristics, or even short-term noise, which have generally not produced a desired long-term outcome.
Please reach out to your BDO Wealth Advisor with any questions.
Opinions expressed in this commentary may change as conditions warrant and are for informational purposes only. Information contained herein is not intended to be personal investment advice for any specific person for any particular purpose. We utilize information sources that we believe to be reliable but cannot guarantee the accuracy of those sources. Past performance is no guarantee of future performance; investing involves risk and may result in loss of capital. No graph, chart, formula or other device can, in and of itself, be used to determine with securities to buy or sell, or when to buy or sell such securities, or can assist persons in making those decisions. Consider seeking advice from a professional before implementing any investing strategy.
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