In the Market & Economic Outlook, we separate the relevant from the noise, to bring you timely content that helps you on the path to and through retirement!
January Commentary & 4th Quarter 2022 Recap
2022 will go down in history as one of the worst years for both stocks and bonds ever. The S&P 500 Index finished down 20% and the Bloomberg U.S. Aggregate Bond Index dropped 15%, a historic decline for bonds. This combination of losses hasn’t been seen in the last half century. For much of the year, investors struggled with the uncertainty of mid-term elections, the outcome of the Ukraine war and most of all, just how much the Fed was going to raise rates to bring down inflationary pressures.
After two consecutive quarters of GDP decline in the first half of 2022, the U.S. economy bounced back in the 3rd quarter, easing fears of a recession. We continue to believe that a recession is likely in 2023. The Fed must continue raising rates in 2023 to fight sticky inflation, and economic data continues to show weakness. The Conference Board of Leading Economic Indicators has dropped in ten of the last eleven months, and housing continues to struggle.
The real question is: Will it be a mild recession or a deep recession? If it turns out to be a mild recession, we may have already discounted much of the anticipated decline and stocks may not drop much more from current levels. If, on the other hand, we have a more severe recession, stocks would likely test the lows reached back in October and possibly go lower.
There are several key events or unexpected shocks that could cause a deep recession, namely a financial system shock or a worsening of geopolitical conditions, particularly with China & Taiwan or Russia & Ukraine. The most likely event that would cause a deep recession would be excessive tightening on the part of the Fed. The Fed has a tough job ahead of them to raise rates enough to bring inflation back to targeted levels without overshooting the mark.
As we embark on a new year that brings continued uncertainty, we are focusing on a few key areas in client portfolios:
- Keeping bond maturities short to intermediate. For the first time in over a decade, short-term financial instruments are providing competitive returns. Highly liquid money market funds are yielding over 4.25%, FDIC-insured CDs in the 1-2 years range are yielding 4.65% or better. Short and intermediate term bond values also tend to be significantly more stable in a rising interest rate environment.
- Increasing allocations to high-quality dividend growth stocks. Growth stocks have dominated the landscape for years, but with rising interest rates, their earnings are less valuable. Value and rising dividend stocks tend to perform better than growth stocks in a rising interest rate environment. Consequently, we have been adding to these areas as opportunities present themselves.
Stocks and bonds had their worst year in over a half century. We believe a recession is likely in the first half of 2023. The Fed will likely determine whether we have a mild or deep recession, depending upon the extent to which they tighten. Investors with cash to invest should consider short-term bond instruments, value stocks and rising dividend companies.