Year in Review 2022

Back in January 2022, we released a piece on mean reversion and how we felt the last few years of strong stock performance was unlikely to continue into the future.  For as much as we speak about the hazards of attempting to “time the market,” this piece was ironically very timely.  

Inflation concerns, geopolitical tensions and growth headwinds have forced most asset classes lower this year and portfolio performance has reflected these challenges.  As we head into the remainder of 2022, we wanted to summarize the current state of markets and what the future may hold as we turn the page to a new year.

1. Inflation was not transitory

During 2021, the Fed reassured markets that increasing inflation prints were transitory in nature and that inflation would moderate into 2022.  The opposite happened as inflation moved to its highest level since the early 1980s.

2. Labor remains very strong

Unemployment peaked during the onset of the COVID pandemic back in March 2020.  Since then, demand for labor has picked up tremendously which labor supply has remained constrained.  This has driven up wages and left employers struggling to fill positions. As of October 2022, there are about 1.7 jobs available for every unemployed person in the US.

3. Fed has been aggressive with interest rate hikes

The US Federal Reserve Bank has a well-defined dual mandate.  This means that the fed has two goals: maximize employment and keep inflation low and stable.  From the last two points, you can see that the Fed is achieving the “employment” goal but needs to focus on reeling-in inflation.  Because labor and the underlying economy remain strong, the Fed has been very aggressive in raising interest rates this year to dampen economic activity and inflation.  This has created two major concerns.  Namely, will the Fed effectively lower inflation with this strategy and how much will tightening financial conditions impact economic growth.

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4. Higher interest rates have punished markets, specifically bonds

Bonds and interest rates have an inverse relationship.  As yields increase, bond prices fall and vice-versa.  Given the aggressive stance by the Fed and higher rates, existing bond portfolios have been marked down this year, sometimes considerably depending on how sensitive the respective bonds are to interest rates.  Even treasuries are not immune to this relationship.

5. Stock market volatility has been elevated

Stock markets have been more volatile this year than last year.  This is mostly driven by uncertainty around the path of interest rates and how this will impact economic growth.  Stock market volatility, as measured by the CBOE S&P 500 Volatility Index (VIX) has remained consistently above its 10-year average this year.

Unfortunately, despite a resilient labor market and more benign recent inflation figures, our feeling is that there will be more economic uncertainty next year with continued headwinds for markets.  Some things that we are keeping a close eye on as we move into 2023 include the following:

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1. 10yr-3mo inverted yield curve as a predictor of recessions

There has been a lot of discussion around the inverted yield curve.  All this means is that long-dated treasury yields are lower than certain shorter-term treasury yields.  This is atypical for markets as investors should expect to be paid higher yields for investing in longer-term bonds.  When the 3-month treasury yield is higher than the 10-year treasury yield, this has predicted the last four recessions (going back to 1985).  Keep in mind that this is not a hard rule, but it does show that investors are concerned about the economic outlook and the yield curve is reflecting that.

2. Stocks are not down *that* much in historical context

Relative to prior periods of market volatility, the S&P 500 has not declined as much as it did during the 2000’s Tech Bubble or the Great Recession.  This doesn’t mean that stocks will definitively reach those levels, but if earnings decline and economic growth contracts, we could see a protracted decline in equities into next year.

3. We expect bond market performance to moderate as interest rates stabilize

Although there is the possibility for more market volatility next year, we feel that the performance of bonds should moderate as interest rates hopefully normalize into next year.  The Fed recently released economic projections and raised the median expected terminal Fed Funds rate to 5.1% next year.  Markets like certainty, and although the Fed has done a poor job of predicting the rate and inflation path heading into 2023, our feeling is that rates will begin to stabilize and potentially even decline depending on economic conditions.

*Data provided by Board of governors of the Federal Reserve System

4. Not all recessions are the same

Nobody wants to see a recession.  Recessions come with market turbulence, increased unemployment, and economic stress.  That being said, markets have been through many recessions, and they are a natural part of the business cycle.  Going back to 1953, there have been 11 recessions as defined by the National Bureau of Economic Research.  Some of these recessions are accompanied by a deep contraction in economic activity and decline in valuations; others are less severe.  This is the debate that investors are wrestling with as we head into 2023.  A recession feels likely and market sentiment points in that direction, but it’s impossible to predict exactly how markets will respond.

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2022 was certainly not the best from a market performance perspective, but there is some silver lining as we head into the new year.  Labor markets remain resilient (for now), inflation appears to be peaking, and a more stable interest rate environment should be supportive of bond performance.  Although there are rumblings about a potential recession, it is important to remember that it is very difficult to predict not only the timing of recessions, but how severe they will be.  For that reason, maintaining a diversified portfolio, keeping adequate cash reserves to cover any known major expenses and planning for volatility is a sound plan for 2023 and beyond.

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Disclaimer:

Past performance is no guarantee of future results. All investing is subject to risk, including the possible loss of money you invest. Fluctuations in financial markets could cause declines in the values of your account. There is no guarantee that any particular asset allocation will meet your objectives.

Past performance does not guarantee future results, which may vary. The indices are unmanaged and the figures for the Index reflect there investment of dividends, but do not include any deduction for fees, expenses or taxes.

Summit Financial, LLC. is a SEC Registered Investment Adviser (“Summit”), headquartered at 4 Campus Drive, Parsippany, NJ 07054, Tel. 973-285-3600. It is provided for your information and guidance and is not intended as specific advice and does not constitute an offer to sell securities. Summit is an investment adviser and offers asset management and financial planning services. Indices are unmanaged and cannot be invested into directly. Data in this report is obtained from sources which we, and our suppliers, believe to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Consult your financial professional before making any investment decision. Past performance is no guarantee of future results. Diversification/asset allocation does not ensure a profit or guarantee against a loss.

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