2022 was brutal. Stocks closed out the year on Friday with the S&P 500 finishing in bear market territory after falling 0.25% on its final day of trade – closing out 2022 down 20%. The Dow Jones Industrial Average faired a tad better on a relative basis, but still lost almost 9% for the year, while the tech-heavy Nasdaq was battered, plummeting over 33% in a year that “FAANG” investors would like to forget.
The culprits for the bear market are clear: The Fed, continued COVID shutdowns in China, soaring inflation, a weakening consumer, “technical” recession in the US, sky-high energy prices, Russia’s invasion of Ukraine, out of control government spending, and, oh, did I mention The Fed?
In a Reuters report in June of 2021, The Federal Reserve Chair, Jay Powell, reaffirmed that the US Central Bank’s focus remained on a US job market recovery, and, at that time, he had vowed not to raise rates too quickly based solely on inflation expectations, but rather, the Chairman proclaimed that The Fed “will wait for evidence of actual inflation or other imbalances” despite its own inflation expectations doubling for that year-over-year period from 1.7% to 3.4%. In the article, The Fed went on to say that the economy was improving “rapidly” and, as a result, was “reshaping” their views about when to reduce quantitative easing “efforts” as the pandemic crisis was receding. During its meeting a week prior to the Reuters report, Fed officials had indicated that they may raise interest rates “as soon as” the year 2023 and had been signaling at that time, those rate hikes may come a year earlier than expected – meaning the intention was not to hike rates until 2024!
A year later, I put out a message to clients. The title of that post read that The Fed was “On the Ropes”, as inflation had soared to 40-year highs and prices across the board were towering over a consumer whose wages couldn’t keep up. (Check out the full post by clicking HERE). And even though Powell and company, after sobering up regarding our runaway inflation problem, did an about-face and hiked rates in both its March and May FOMC meetings, it seemed that they were still missing the mark and (as I had been saying at that time for more than a year) were still way behind the proverbial “curve”. The date of that post was June 10, 2022, and since then, The Fed, in a direct response to soaring inflation, has raised the overnight lending rate in its last five straight meetings taking that target to 4.5% up from basically 0% where it had been held for years.
What happened to The Fed holding to its commitment of not hiking rates at all in 2022 while waiting to see actual inflation and otherimbalances??? Their denial has vanished – that’s what happened.
It’s important to remember that The Fed was keeping rates at zero as recently as the first quarter of 2022 and while home buyers were in bidding wars with each other in the real estate market, The Fed was on a spending spree buying billions of dollars of mortgage-backed securities every single month to continue to “stimulate” the US economy. As I also stated in my last message, this was occurring after we all watched inflation go from under 2% at the end of 2020 to nearly 9% by the middle of 2022 and you may recall that according to Mr. Powell as well as Treasury Secretary, Janet Yellen, all of that inflation was “transitory”, right?
Okay, so what’s next? Is recovery in store for 2023? Let’s take a look at what’s in front of us:
- The Interest Rate Cycle: Many analysts agree that rate hikes will have to end this year amid the possibility of recession here in the US. At this point, if The Fed hits the brakes, that would mean inflation would be lower – that’s a good thing and can provide a “tailwind” for certain areas of the market that may be worth considering.
- Fed Funds Will Peak: Those same analysts also agree that, even if rates go higher than expected, Fed Funds will most likely peak somewhere between 4.75% and 5.25% in 2023. Areas of the market, including banks, financials, and perhaps even technology may be pricing this factor in over the near-term as I write this post (but, of course, time will tell).
- Rates Stay ‘Higher for Longer’: The Fed’s inflation targets may require higher rates for longer periods of time. That said, ‘higher for longer’ may equate to lower inflation but also the possibility of a “normalization” of interest rates which can reduce the “boom to bust” environment that we have all (for better or worse) come to know so well. This could even lead to small rate cuts and some easing from The Fed which, if done right, could restore confidence.
- Interest Rate “Catch Up”: Historically, it can take anywhere from 6 to 18 months for the affect rate hikes have to show up in economic data and since The Fed has only recently ramped up rates, it is possible that a meaningful reduction in inflation is still yet to come, as rate hikes “catch up” within economic reporting going forward.
- Observe Caution: Even though the markets got whipped in 2022, investors should be on the lookout for continued volatility and market woes. History may be on our side to some extent and recouping losses in the markets can be possible, but it’s crucial to maintain responsibility when managing investment portfolios and addressing risk premiums….Observe caution in light of the recent meltdown in certain areas of the markets.
- Maintain an Appropriate Asset Allocation Strategy: Understanding the impact market valuations have on asset classes and recognizing that there is a distinct possibility for an earnings recession in 2023, will be key to the proper allocation of portfolio assets this year. In many conversations that Capstone’s advisors have had with clients for over a year now, controlling risk has been at the forefront of portfolio management. As I mentioned in my June 10, 2022 message as well as several messages prior, we took “cover” in certain areas of client portfolios near the end of 2021 and the beginning of 2022, in order to get through rough waters that we thought were on the horizon while focusing on reducing “downside” capture and overall risk. Asset allocation is key!
Investment and portfolio management is always relative to an underlying benchmark and is not a “perfect science”. And, NO, Capstone advisors do not have a crystal ball when looking forward. What we do have is over 60-years of combined experience in managing money and portfolio risk and, frankly, as a constant reminder for clients and investors at large, it is impossible for anyone to “outsmart” the markets, we just need to navigate our way to the next move higher and expansion in the business cycle. Remember, getting through a rough patch is a process, not a transaction…and unfortunately, sometimes the process can take months or even years to complete but getting through bad times in a dependable manner will assist almost every investor in creating better retirement outcomes over the long haul.
For any clients reading this post, please, as always, contact us with questions regarding your investments and/or financial plan. If you are not a Capstone client but have concerns about the management of your investment portfolio and would like to learn more about our approach for the coming year, please also feel free to contact us at 888-587-7526 (toll free) or at (570) 587-7800(office direct).
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.