In hindsight, we could have recognized at the start of 2022 that US investment assets were priced for a strong and stable global economy. Fueled by COVID-related government spending and primed by low interest rates, asset values were unsustainably high. The S&P 500 index was at an all-time high, with many company stock prices more than double their pre-COVID values, and most bonds were priced at significant premiums, well above their maturity values. Investors projected forward the current market conditions and expected the good times to continue. However, inflation disrupted expectations.
Even though US inflation increased from around 1.5% annually in January 2021 to close to 7% by the end of 2021, it was not until March of 2022 that the Federal Reserve Bank raised the Fed Funds Rate by a timid 0.25%. The Fed got serious about taming inflation in June with a more aggressive 0.75% increase and they raised the Fed Funds Rate by a total of 4.25% for the year. The US central bank was too slow to start fighting inflation and by mid-year investment markets had already reacted to an annual inflation rate running at 9%. The S&P 500 index finished the year down over 18%. Bonds, which often provide support when stocks decline, did not perform much better, as the Bloomberg US Aggregate Bond index finished the year down over 13%.
As we enter 2023, investment valuations appear more favorable, particularly for bonds. The yields on all fixed income securities have risen to interest rates not seen since before the financial crisis in 2008. Monthly interest payments are up significantly from the low rates available since 2009 and provide a solid starting point for bonds in 2023. Government money market fund yields are approaching 4% and may tick higher in the first quarter as the Fed Funds Rate is expected to increase by another 0.5%-1.0% before the Fed pauses and assesses if it has done enough to fight inflation.
Stock prices will continue to be volatile in 2023 as businesses navigate an economy still struggling to emerge from the global pandemic. Some analysts expect corporate earnings to decline as the economy moves toward a recession. But US consumers have been resilient, supported by a job market that continues to recover from COVID disruptions. If earnings come in at or above low expectations, there could be a positive rise in stock values. In a slower-growth economy, dividend-paying value stocks may provide more stable earnings than growth stocks whose revenues could slip. We saw this in 2022, when the growth-oriented NASDAQ Index was down 32% while the value-oriented Dow Jones Industrial Average was down “only” 7%.
Outside the US, 2023 could be the year foreign stocks revert to the mean and outperform US stocks. US investors face additional political risks in global investment markets, including the Russia-Ukraine war and China’s recent surge in COVID cases. The US dollar moved strongly higher in 2022 but it looks like that trend is starting to reverse. American investors in foreign stock benefit when the US dollar declines and a resolution in Ukraine and improved health in China could lead to better economic growth outside the US.
Hindsight is 20/20 and none of us have a crystal ball, but investors have reasons for optimism as 2023 begins. If inflation continues to decline from its peak annual rate of 9% in June 2022, US interest rates should follow lower. If the global economy avoids slipping into a recession and geopolitical risks subside, corporate earnings could remain stable or surprise to the upside.
This article was authored by Christopher Borden, a financial advisor and Managing Partner located at Canby Financial Advisors, 161 Worcester Road, Framingham, MA 01701. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 508.598.1082 or email@example.com.
Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. Investments are subject to risk, including the loss of principal. Because investment return and principal value fluctuate, shares may be worth more or less than their original value. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Talk to your financial advisor before making any investing decisions.
The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Bloomberg US Aggregate Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar- denominated, fixed-rate taxable bond market.
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