The past year was a difficult one for investors. For stocks, 2022 was the worst year since 2008 and the fourth worst year since 1950. The bond market did not fare much better with the Aggregate Bond index* having its worst year on record with a total return of -12.03%. The previous worst year for the Aggregate Bond index was in 1994 when the total return was -2.9%. After the turbulence of 2022, investors are looking forward to the potential that many of the headwinds will start to subside.
The accommodating low interest rate environment the Federal Reserve implemented in the spring of 2020 carried over to start 2022 with interest rates near zero. The Federal Reserve had been targeting a range between 0% and 0.25%. With inflation no longer appearing to be transitory, the Federal Reserve instituted aggressive monetary policy, continuously revising and increasing their expected targeted federal funds rate throughout the year. In their December meeting, the Federal Reserve increased their targeted range between 4.25% and 4.5%, the highest level in 15 years. The Fed is projecting they will need to be less aggressive in 2023, increase rates another 0.75% throughout the year, and by 2024 potentially evening beginning to cut rates.
Traditionally, bonds have been an important asset class for investors, especially retirees who desire stable income to meet their income needs. With the Fed keeping rates near zero over the past decade, many retirees chased yield by fleeing to stocks as bond yields were incredibly low. With the increase in interest rates, bonds are once again offering meaningful interest with the potential benefit of appreciation in bond prices if inflation starts to ease and yields begin to fall. While the ride down was difficult, this is a long-term positive for yield seeking investors.
Inflation started to slow late last year and is expected to continue to slow. Slowing inflation has lead to hopes that there will be a Fed pivot, meaning the Federal Reserve pauses interest rate hikes. With investors closely monitoring inflation readings and Fed Chairman Jerome Powell’s comments so closely, we are guarding against the fact that investors could put too much weight into a single reading or Fed comment, causing the markets to overreact.
Going into 2023, talks of a recession are likely to increase. An official recession is determined by the National Bureau of Economic research and makes use of more economic data than the commonly used definition of a recession being two consecutive quarters of negative GDP growth. An unemployment rate under 4%, having nearly two job openings for every job seeker, and homeowners having the highest equity levels in their homes since the early 1980’s, the base case is now that any recession, if it occurs, should be mild.
Overall, expectations for the economy and markets are low entering 2023. The market reflects known and anticipated information. The good news is that lowering the bar makes it easier to exceed expectations and that’s what tends to drive stock returns. Recessions are backward-looking while markets are forward looking. Very often markets begin their recovery during the recession. Patience will be key for investors as the benefits of diversification should re-emerge and provide the long-term results we are all looking for.