Investment Management Newsletter - 4th Quarter 2022

2022….... A Year to Forget?

While 2022 saw some normalization on Main Street with most remaining mask mandates dropped, school norms returned, and employees returning to the office, Wall Street saw anything but normalcy. Volatility ruled the year in stock, bond, commodity and currency markets. The S&P 500 fell 18.1% for the year on a total return basis and was in bear market territory for much of the year. This made 2022 the worst year for stocks since 2008 and the fourth-worst year since World War II.

As mentioned in last quarter’s newsletter, not only were stocks down by double digits, but bond total returns were as well. The Bloomberg U.S. Aggregate Bond Index fell 13.0% during 2022. Normally, investors enjoy diversifying effects of having both bonds and stocks in a portfolio. This year was different. For the first time since 1872, both the 10-year Treasury bond and S&P 500 fell more than 10.0%. Even more surprisingly, the 10-year Treasury bond posted its worst return since 1788. Correlating with this price drop, the yield increase of 2.4% was also the largest since 1788.

Amidst these dour statistics, where does this leave investors as 2023 begins? From a stock perspective, valuations have nearly returned to long-term averages, giving a reason for optimism regarding future returns. The stock market has already priced in slower economic growth. Stable and rising growth or better-than-expected corporate earnings could easily serve as a catalyst for investors to bid up stock prices. Meanwhile, long-term bond yields have risen considerably and now appear to be plateauing. Higher initial rates for bond investors will make positive total returns easier to achieve. While the Federal Reserve is still on track to raise short-term rates, these increases have little impact on long-term bonds. Inflation expectations have a large impact on long-term bond yields, and many inflation indicators have steadied or appear to be moving in the right direction which also supports a positive outlook for bond returns.

The Fed’s Part in This

The Fed Funds rate started the year at a range of 0.0%-0.25%. As inflation appeared to be more persistent than transitory, the Fed embarked on one of the most aggressive rate-increasing campaigns in history, beginning in March by taking Fed Funds from an effective rate of 0.08% to 4.33% by December. With the labor markets remaining strong, very little stood in the Fed’s way as Chairman Powell remarked that “pain” was ahead. Even though financial markets felt the downside of the rate increases, the Fed is still expected to increase interest rates by a total of 0.75% over their next two meetings in their attempt to get the abnormally high inflation rate under control. This may put the economy into a recession, though we share the consensus view that it could be relatively mild. If inflation is not reduced toward the Fed’s 2% target, they will be back where they started last March, and the next round of rate hikes will be much more painful.

Fourth-Worst Drop Since 1948

There were few places to hide during 2022. In fact, the only two positive sectors were Energy and Utilities. Value stocks outperformed growth stocks by 21.6% (Russell 1000 Growth and Russell 1000 Value) as future earnings and earnings growth had to be discounted at higher rates. The tech-heavy Nasdaq composite reflected this the most as it fell 32.4% during the year. Mid cap and small cap stocks fared better than large cap stocks with declines of 12.7% and 15.8%, respectively. 

Developed market international stocks provided some relief to domestic peers as the MSCI EAFE dropped only 13.4% during the year. This comes in spite of the dollar strengthening by 8.2%, which would tend to decrease returns for U.S.-based investors. At its peak in September, the dollar was 19.2% stronger than at the start of the year. Some dollar index components faced extreme volatility as central banks took aggressive action to combat inflation. The Euro fell below parity (1 Euro/Dollar) for the first time since 2002. After significantly weakening all year, the Japanese Yen surged the most of this century after the Bank of Japan shifted its yield curve control policy following multiple currency interventions. The Bank of England was forced to intervene in its bond market after its “mini-budget” caused the Pound to weaken dramatically. These shorter-term events pale in comparison to the longer-term effects resulting from the war in Ukraine and the rolling COVID lockdowns in China.  

The Economy

There is still debate about whether the economy entered a true recession in the first half of the year as we met the technical definition of two consecutive quarters of negative GDP growth; however, other indications of a recession were absent. The economy came roaring back during the third quarter, expanding at an annualized rate of 3.2%. Expectations are for strong fourth-quarter growth as well. For 2023, economists have a much more subdued outlook as estimates for growth are nearly flat. A reversal of the wealth effect — the tendency to spend more when one’s asset values rise — will likely lead to lower consumer spending in the year ahead, not only because of the decline in investment values but also because home values are diminished by rising mortgage rates. While some companies have announced large-scale layoffs, the overall labor market remains strong. In fact, the November Job Opening and Labor Turnover Survey data showed open positions outnumbered available workers by a ratio of 1.7 to 1. With almost 10.5 million job openings and unemployment at 3.5%, the job market remains tight by historical standards.

Alternative Assets

Alternative assets proved their worth as diversifiers once again in 2022. Global hedge funds were protected on the downside by losing only 4.4%. Commodities held their own as gold fell only 0.6%. The global infrastructure sector had a similar slightly negative return.  Crude oil increased 6.7%, after rising 50.0% at one point during the year. However, Real Estate Investment Trusts were impacted by higher interest rates and fell 24.3%.

The Broadway Wealth Management Difference

One of Broadway Wealth Management's differentiators has been to focus on quality investments and to err on the side of caution during volatile investment environments. In most cases, our results compared favorably against benchmarks we use to evaluate our performance in managing individual securities in taxable and tax-exempt fixed income, large cap equity, and Real Estate Investment Trusts. As another volatile year begins, our portfolio managers continue to prudently manage our clients’ assets in a challenging environment.

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