Market Update January 18, 2023
It is said that desperate times call for desperate measures. In response to the Covid pandemic and lockdown, on March 16, 2020 the Federal Reserve cut the Federal Funds rate to a target range of zero to 0.25%. They held this rate for a full two years until cautiously raising it to a range of 0.25% to 0.50% on March 17, 2022. As it became apparent that inflation was running out of control, the Fed threw caution to the wind by raising the Fed Funds rate by year end to a range of 4.25% to 4.50%.
Among the casualties of this action were stocks and bonds, with stocks posting their worst returns since 2008 and bonds posting their worst returns in at least 46 years. Large company domestic stocks as measured by the S&P 500 were down 18.1% in 2022. The technology-laden NASDAQ fared even worse, down 32.5%. Established foreign market stocks as measured by the MSCI EAFE index held up relatively well, down 14.5% while the MSCI Emerging Market index was down 20.1%.
While volatility in stocks is not unusual, the volatility in bonds was historic with the Bloomberg U.S. Aggregate index being down 13% in 2022. A blended return calculation using 60% in the S&P 500 and 40% in this primary bond index, a common asset allocation for moderate risk investors, resulted in a -16.1% return in 2022. So much for bonds protecting on the downside. Thankfully, cash alternative investments and ultra-short-term bond funds offered investors some protection from the downside, not to mention a progressively attractive yield as the year wore on.
If there is a silver lining to the Federal Reserve’s actions this past year, it is that bonds are now finally offering an attractive yield again. During the year, the 10-year Treasury bond hit its highest yield since 2008, topping out at 4.25% while ending the year at 3.88%. Corporate bonds also hit their highest yields in well over 10 years. Higher yields help cushion losses should yields continue to rise and bond prices fall, as happens due to the inverse relationship between yields and prices.
The key driver of stock and bond prices in 2023 is again likely to be inflation and the Fed’s response to it. Recent readings of inflation have certainly improved, especially when you look at month-to-month changes versus the inflation rate over the past year. This data implies that inflation has already passed its peak. Stocks and bonds have taken comfort in this to start the new year. The financial markets are now expecting only a very slight increase in the Federal Funds rate in the first half of the year and are expecting rate cuts later in the year. This optimism may be premature as wage inflation persists. Our country still has a problem in that there are not enough workers to meet demand. So, what is the Fed to do? Kill demand. They have indicated their resolve to continue raising rates for as long as is necessary to dent the jobs market. The danger is that insufficient time has passed to see the impact of the rate increases they have already done. Unfortunately, soft landings of the economy are elusive and a recession seems inevitable. The deeply inverted yield curve, with short-term interest rates higher than long-term interest rates, implies a recession is forthcoming later this year. Only time will tell if it indeed materializes and the magnitude. The upcoming battle in Congress over our country’s debt ceiling may also create volatility.
In the meantime, I believe there are pockets of value to be had in financial assets that will prove to be very profitable over time. As always, not allowing oneself to be swayed into abandoning a long-term strategy when the inevitable volatility comes will be key.
I wish you all the best in the year to come. Please do not hesitate to reach out to me as needed.
Sincerely,
Glenn S. Rank, CIMA®
Certified Investment Management Analyst®
President
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· The S&P 500 is an unmanaged index of 500 widely held stocks that’s generally considered representative of the U.S. stock market. The MSCI EAFE index and the MSCI Emerging Markets index are unmanaged indexes compiled by Morgan Stanley Capital International that are generally considered representative of the developed international stock market and emerging international stock market, respectively. International securities involve additional risks including currency fluctuations, differing financial accounting standards, and possible political and economic volatility, and may not be suitable for all investors. Investing in emerging markets can be riskier than investing in well-established foreign markets. Investing in small cap stocks generally involves greater risks, and therefore, may not be appropriate for every investor. NASDAQ covers 4500 stocks traded over the counter. It represents many small Composite index company stocks but is heavily influenced by about 100 of the largest NASDAQ stocks and is a value weighted index calculated on price change only and does not include income. The Bloomberg US Aggregate Bond index is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the U.S. Inclusion of these indexes is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary.
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