As we enter a new year, it is natural to look back and reflect on the year that just passed. What milestones will we remember? What were the lessons learned? What are our goals and expectations for the coming year?
When looking at our clients’ financial picture, we take this same approach with a 2022 market review. What will we remember about last year’s market performance, both good and bad? What have we learned that we can apply as we move forward? Where do we see the economy headed in 2023?
2022 Market Review
It was a rough year in the markets and economy. We experienced record inflation, unlike anything we have seen in decades. The Federal Reserve (Fed) raised interest rates at a pace we have not seen in quite some time. Geopolitical risk was persistent as Russia’s invasion of Ukraine extended into a war that spanned the entire year and is still ongoing. All of this occurred against the backdrop of looming recession fears around the world.
In the capital markets, there were few places to hide as almost every asset class posted solidly negative returns. Energy was one of the few areas of the market that was positive on the year. The S&P 500 Index, which is a barometer for U.S. large cap stocks, retracted 18 percent this year, its worst year since the Global Financial Crisis of 2008. Returns in international markets were also dismal and on par with U.S. returns with the MSCI ACWI ex-U.S. Index posting losses of 16 percent.
Some areas of the market fared better than others. For example, large-cap value-oriented stocks (as defined by the Russell 1000 Value Index) lost just shy of 8 percent for 2022. While not great, this is favorable compared to the performance of growth-oriented and technology stocks. The Russell 1000 Growth Index lost almost 30 percent in 2022, its worst calendar year performance in over a decade. The tech-heavy Nasdaq Index was down over 32 percent for the year.
Bonds did not provide any respite for investors. Yields rose at an unprecedented pace as the Federal Reserve tried to combat inflation. The yield on the 10-year U.S. Treasury, which is a bellwether for overall interest rates, rose from 1.5 percent at the start of the year to almost 4 percent at the close of December. The Bloomberg Aggregate Bond Index lost 13 percent in 2022, the worst year in the history of the index.
Are There Any Silver Linings?
This paints a pretty bleak picture of what we just went through for our 2022 market review. Was there anything positive that happened in 2022 in the markets? Surprisingly, yes, there were a few silver linings.
One silver lining of 2022 was rising bond yields. At first, this may seem crazy since the bond market was down double digits in 2022. How could this possibly be a good thing? However, when we look longer term, higher rates are actually favorable for bonds. While it is painful getting there, the higher rates we are seeing today give a much better income opportunity than we have seen in the last several years.
For example, let’s look at the yield on a U.S. Treasury bond maturing in 5 years. At the beginning of 2022, this figure was only 1.3 percent. Fast forward to the end of the year, and you can earn 4.0 percent on a 5-year U.S. Treasury. This is an increase of almost 3 times! This is a much more attractive investment than it was just one year ago.
Another silver lining of our 2022 market review is more favorable equity valuations. While it does not feel good to go through a market downturn like we did in 2022, the end result is lower stock prices for future investing. With stock market indices falling anywhere from 7 percent to 32 percent, we are seeing much more compelling entry points than we were one year ago.
As we look back with our 2022 market review, it is important to ask ourselves what we learned amidst the market downturn. Are there any lessons that we can use as we move forward? Was there anything that confirmed or disputed the tenets of investing?
We’ve all heard the saying “Don’t put all your eggs in one basket.” This was proven true in last year’s financial market performance. You may be asking “How does diversification matter if both stocks and bonds are down at the same time?” It’s a legitimate question. But diversification goes beyond just stocks and bonds.
There were very wide dispersions in performance of various asset classes in 2022. Even though most returns were negative, diversification made a difference in portfolio returns. With growth and technology areas of the market seeing returns in the negative 30 percent range last year, investors who were overweight in these areas felt a larger blow. The dividend-paying value sector was only down 7.5 percent, which is a far cry from the negative returns in the growth area. Having a diversified asset allocation within stocks and bonds made a difference for investors, even amidst last year’s turmoil.
Cash Management Is Important
When the markets are volatile and you must sell investments to raise cash, you may be forced to liquidate portions of your portfolio at inopportune times, locking in negative returns. If you have large expenditures or cash needs for the future, it is important to keep us informed so we can plan for these ahead of time.
Tread Lightly with Speculative Asset Classes
Cryptocurrency saw an extreme and rapid correction in 2022 amidst the fall of Bitcoin, breakdown of Terra, and collapse of cryptocurrency exchange FTX. The market cap of digital assets fell from a high of $3 trillion in late 2021 to roughly $800 billion at the end of 2022 according to CoinMarketCap.
This has reiterated the notion that speculative asset classes, such as cryptocurrency, should be approached with the utmost caution. Do not invest more money than you can afford to lose.
Focus On What You Can Control
None of us can control what happens in the economy and markets. While it can be unnerving when the markets fall as they did in 2022, it is important to remain focused on the bigger picture. Don’t let emotions rule the day. Do not make irrational decisions in times of market stress. Review your goals and let us know of any changes. The key to long-term investing is to maintain a diversified portfolio with an allocation in alignment with your financial goals, rather than making emotional decisions based on short-term market movements.
Looking Into the Crystal Ball after a 2022 Market Review
Probably the biggest question on everyone’s mind is: What is going to happen in 2023 and beyond? We see reasons for optimism, but also acknowledge that risks and uncertainty persist.
The Fed has been clear that they will continue to raise rates until data indicates inflation is subsiding. Whether or not they can do this without pushing the economy into a recession remains to be seen. The good news is that inflation, while still high, has shown signs of moderating. Also, if we fall into a recession, it is likely to not be as long or deep as some that we have experienced in the past.
Could we be facing some rocky times ahead in 2023? Most likely, particularly in the first half of the year. Could we fall into a recession? Yes, we could. Would these events be a surprise? Absolutely not.
It’s important to remember that rough waters are natural in a full economic and market cycle. The chart below shows historical performance of the S&P 500 Index from 1942 through September 2022. The blue areas represent bull markets, or periods of market expansion, and the yellow areas represent bear markets, or periods of market contraction. The gray bars show periods of economic recession.
You can see that the size and number of the blue areas are much larger than that of the yellow areas. This means the times of expansion in the market outweigh the times of corrections. Over the longer term, the general trajectory of the markets is upwards. This illustrates the benefits of investing for the long term and not being distracted by periods of shorter-term volatility.
Chart Source: First Trust. Data Source: Bloomberg. Daily returns from 4/29/1924 – 9/30/2022.
Side by Side
If you are not sure what you should know about your financial picture after last year and want to make sure you are on a clear track to reach your financial goals, our advisors a Domani Wealth are always willing to start a conversation or share a second opinion. You can get in touch with anyone on our team or you can call 855-855-5455, or reach out to [email protected].
Sources: Bloomberg, Callan, First Trust
Important Market Review Disclosure:
Domani Wealth, LLC (“Domani”) is an SEC-registered investment adviser with its principal place of business in Lancaster, Pennsylvania. Domani may only transact business in those states in which it is notice-filed, or qualifies for an exemption or exclusion from notice-filing requirements. This communication is limited to the dissemination of general information pertaining to its advisory services. Accordingly, this communication should not be construed by any consumer and/or prospective client as Domani’s solicitation to effect, or attempt to effect transactions in securities, or the rendering of personalized investment advice. Any subsequent, direct communication by Domani with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of Domani, please contact the SEC or the state securities regulators for those states in which Domani maintains a notice-filing. Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Domani, or any non-investment related content, made reference to directly or indirectly in this communication will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this communication serves as the receipt of, or as a substitute for, personalized investment advice from Domani. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Domani is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the Domani’s current written disclosure Brochure discussing our advisory services and fees is available upon request. Please Note: If you are a Domani client, please remember to contact Domani, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. Domani shall continue to rely on the accuracy of information that you have provided.