The year 2022 was challenging for investors. The highest inflation in four decades and the Russian invasion of Ukraine sparked selloffs across all major markets. For the first time since the S&P 500 and Barclays US Aggregate Bond Indexes have been tracked, stocks and bonds both fell over 10%.
For much of the year, it felt as though sparks of hope were few and far between as the S&P 500 scored gains on the fewest trading days in any year since 1974. Thankfully, the fourth quarter brought some reprieve from the barrage of selling as stocks and bonds clawed back some of their losses.
Difficult times are usually a good time for introspection. Looking back, here are some important lessons from 2022:
For over a decade, inflation lingered around 2% annually despite practically free borrowing costs as the Federal Reserve and other central banks around the world pegged interest rates at close to zero. That changed in 2021 when prices rose quickly as COVID shutdowns caused manufacturing and shipping issues, limiting the availability of many products from lumber to pickup trucks. Inflation further accelerated in February 2022 when Russia invaded Ukraine, propelling energy prices higher by over 30%.
Inflation, as measured by the 12-month price increase of the Consumer Price Index, peaked at 9.1% in June—far above the 2% level we had become accustomed to. The effects were impossible to avoid. Even the hedges typically used to protect against rising prices—gold, commodities, inflation-protected Treasury bonds, real estate, and cryptocurrencies—fell in 2022. CPI inflation eased to 7.1% in November as energy prices and supply chain issues abated but costs for housing and services continue to rise.
The Fed stepped up to battle inflation by raising interest rates at the fastest rate since the early 1980s. The overnight lending rate between banks was hiked by 4.25 percentage points in 2022, rocketing borrowing costs higher. Mortgage rates more than doubled during the year, making buying a new home much more difficult for prospective buyers.
Despite positive S&P 500 earnings in 2022 and no economic recession, rising rates led to a major repricing of investment assets. Over the long term, growth and profitability drive returns but over the short term, interest rates rule.
Higher rates quickly squeezed stock and bond valuations. Prices of existing bonds paying 2021 interest rates fell to match the attractiveness of newly issued bonds offering higher yields. Likewise, stock dividends, which had been higher than bond yields, became much less desirable as bond yields rose.
Tracking only investment prices, you’d have expected to see US households badly hurting, but that hasn’t been the case yet as the labor market continues to stand strong. Through November, US unemployment remains at a low 3.7%, with hourly wages rising by 5.1% over the past 12 months.
Perhaps the largest marker of worker confidence is the number of people quitting their jobs. Workers generally don’t leave a job without a new one lined up or confidence that they can find a new job when ready. Since June, we’ve seen over 4 million workers quitting their jobs every month—higher than at any point this century.
We’ve enjoyed rising markets since the Financial Crisis ended in 2009. Even the COVID-fueled bear market of 2020 hardly registers as a blip on long-term charts because stocks recovered so quickly. 2022 taught us that markets can still go down. We’re currently experiencing a deep and extended bear market. Stocks may have already risen from their lowest point, but we may also see prices return to lows and fall further. The good news is that stocks are undefeated when it comes to recovering from bear markets. The S&P 500 recouped losses from each of the last 21 bear markets and continued moving higher. It is just a matter of time.
We don’t want to see markets fall—Bragg Financial employees are invested right along with our clients—but we were ready for 2022. Your portfolio managers used the bear market as an opportunity to harvest losses and rebalance portfolios, adding to investments trading at much lower prices.
Over the past several years, we have missed out on buying hot investments promising to grow to infinity. Warren Buffett says, “Only when the tide goes out do you discover who’s been swimming naked.” Well, the tide went out in 2022, offering a more sober look at many of the high flyers from recent years. Investments like cryptocurrencies, ARK Funds, and high-growth, low-profit stocks like Tesla and NVIDIA came crashing back to Earth. The price you pay matters and at Bragg Financial, we work hard to invest in high-quality companies with stable earnings growth. It can be a less exciting strategy but is one we believe will work, as opposed to betting on unproven growth stories.
Heading into the new year, the perspective on many major storylines from 2022 has started to shift. Here’s what we’re watching for in 2023:
While still far above 2%, the falling trend of inflation over the second half of 2022 is promising. The Fed began slowing the pace of rate hikes in December, raising rates by just 0.5 percentage point compared to the 0.75 percentage point increases in each of the previous four meetings.
The Fed has only been able to raise interest rates as quickly as they have because the economy has withstood the effects of the hikes. That is likely to change this year. While rate increases immediately increase borrowing costs, the full effects typically take about nine months to filter through the economy and change spending behaviors. That means we have not yet seen the full impact of higher rates on the economy. The labor market and consumer spending are likely to weaken over the first half of 2023 and we may well see the economy start to contract.
Once the Fed concern shifts from inflation to a recession, the current rate-hike cycle will come to an end. Fed governors believe they can simply stop raising interest rates when the time is right. That alone would greatly ease the pressure on stock and bond prices, but that’s not what the Fed has done in the past. More often, the Fed must reverse course more quickly to start lowering rates at the onset of a recession. If that happens, we could quickly see rising investment prices, regardless of economic weakness.
If the labor market and consumer spending start to deteriorate over the first half of the year, so will company profits. Earnings for the S&P 500 companies are projected to grow just 0.7% in the first quarter and 0.3% in the second quarter according to FactSet. That doesn’t leave much room for error. None of this is much of a surprise, as lower stock prices have been projecting a coming pressure on profits.
Luckily, earnings growth is expected to return over the back half of 2023 and S&P 500 growth for all of 2023 is projected to rise 5.3%.
Interest rates were held artificially low over the past decade by central banks around the world. As a result, bonds have paid little interest to investors for several years. This made investing in fixed income difficult since bond returns come almost entirely from the income they pay. Today, we can actually earn a real return from bond coupons, with 10-year Treasury bonds ending 2022 paying 3.88%. No longer will income investors be pushed into higher-risk investments in search of yield. The outlook going forward is more upbeat because the bulk of the Fed’s interest rate hikes are in the past, meaning that most of the damage to prices has already been done. For the first time in a long time, bonds will be a contributing factor to making a “balanced portfolio” more balanced.
Markets ended a brutal 2022 on a high note. We don’t know yet if fourth-quarter trends will continue or if prices will dip again, but either way, volatility seems likely to continue into 2023. We do know that over time, the best returns are often defined by the mistakes we don’t make. A long-term investment plan makes decision making much easier when emotions run high. The investment committee at Bragg meets weekly to ensure we are sticking to our plan: continue to invest in companies with established track records and balance risk with a diversified portfolio. Diversification is as important as ever as the market goes through a major shift. It is too early to tell which investments will lead us out of this bear market, but it will end eventually, and we want to be fully invested when it does.
This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.