EQM Indexes 4Q 2022 Market Review

Most investors are happy to get 2022 behind them, as the S&P 500 Index experienced its worst year since 2008’s financial crisis, down 18.1% on a total return basis. High growth tech-stocks fared even worse, with the NASDAQ Composite experiencing a 32.5% decline and Small Cap Russell 2000 stocks were down 20.4%.

There were a few places to hide in the stock market. The Dow Jones Industrial Index was down only 6.9% and the Energy sector, helped by a spike in prices exacerbated by the Russia-Ukraine conflict, was a top-performing sector with the Energy Select SPDR Fund (XLE) up a whopping 64.2% for the year.

Investors hoping that diversification into bonds would help hedge their equity losses were disappointed amid a rising interest rate environment that resulted in the worst bond market performance ummm, ever.  The Barclays Aggregate Bond Index was down 12.5%, providing not much of a “save haven” for investors.

Last year marked a trifecta of pain of High Inflation, Surging Interest Rates, and Fear of Recession, combining to create the market’s first bear market (down 20% from its high) since the brief Covid “baby bear” market decline experienced in March of 2020.

Historically, the average bear-market length is 9-14 months in duration and on average, they occur every 3.5 years.  Do bear markets always coincide with recessions?  Not necessarily.  According to Investopedia, of the 25 bear markets that have occurred since 1928, only 14 (56%) have been followed by a recession.

Based on the inverted yield curve, many are predicting a recession in the coming year.  But Duke Professor Campbell Harvey, the original researcher behind that premise that an inverted yield curve was the harbinger of the last eight recessions, thinks that will not be the case this time. Harvey thinks the strong labor market and heightened risk aversion may help us “dodge a bullet”.

What causes recessions – usually one of three things:  1) oversupply, when economic demand weakens, 2) uncertainty and loss of confidence (like those created by wars and pandemics and an overly hawkish Fed), and 3) speculative bubbles– such as tulips in the 17th century and the housing market in 2008.

Campbell Harvey is not the only economist or investment bank in the “soft landing” camp. Here is a nice synopsis on how divided market pundits are on the prospects for a recession.

Indeed, there are many positive catalyst scenarios that could spare the economy from recession and propel financial markets back into bull market territory in 2023.

1. Bear Market Recoveries – According to the Wells Fargo Investment Institute study, the average 12-month return after the end of a bear market is 43.4%.
2. Inflation Cooling– There is rising evidence that inflation is abating, easing to 7.1% over the past 12 months through November, seeing the smallest increase since December 2021.
3. Fed Pivot – Based on inflation data improvement, the Fed slowed the pace of rate increases to 50 bps in December, after four 75 bps increases in a row. If this continues in 2023 and the Fed “pivots”, both the bond and equity markets would rally.
4. Global Economy Wildcards – Should we see a resolution to the Russia-Ukraine conflict that further eases pressure on energy and commodity prices and/or if China’s abandonment of its zero-Covid policy spurs an economic recovery there, those could re-fuel the global equity markets, especially Emerging Markets.
5. Improved Corporate Earnings – Corporate America faced significant headwinds in 2022 such as cost pressures amid high inflation and a still-disrupted global supply chain. Plus, many companies over-earned during the pandemic, so some reversion to the mean had to occur. Lower inflation could help boost profit margins and corporate earnings growth above expectations.
6. Reasonable Valuations – U.S. stocks have rebounded off their cheapest levels, but ended 2022 the most undervalued since March of 2020. According to Morningstar, there have only been three times when valuations were as low as they are now: the pandemic crash of 2020, 2011′s eurozone crisis, and the global financial crisis of 2008.

Looking ahead, there is still plenty of uncertainty, but there are also many reasons for optimism. That said, market forecasting is notoriously difficult. After all, few predicted last year’s bear market due to a combination of high inflation, rising interest rates, and the Russia-Ukraine conflict which further exacerbated inflationary pressures.

Would the Fed’s transitory inflation thesis have been correct had it not been for the Russian invasion of Ukraine? The inverted yield curve is the manifestation of the market’s confusion, feeling more confident about the future than the near term.

What about Stocks?

Although past performance is no guarantee of future performance, as the saying goes, bear markets don’t last forever. In the few instances when the S&P 500 has dropped consecutive calendar years, it has been due to a major economic event, such as the Great Depression between 1929 and 1939, or a geopolitical shock, such as World War II and the oil crisis in 1972, or both, in the case of the early 2000s when there was the bursting of the dot-com bubble, Sept. 11, 2001, terror attacks and the subsequent U.S. invasion of Iraq. Since 1980 to the present, annual returns for the S&P 500 were positive in 32 out of 42 years – that’s 76% of the time. A good reminder that equity investors who stay the course over the long term will be ultimately rewarded.

How about Bonds?

Another consternation for investors in 2022 was the worst market on record for the U.S. bond market as the Federal Reserve’s unprecedented pace of rate increases, clobbered bond prices, especially on the long end of the yield curve.  Bond’s historic role as a boring shock absorber, helping buoy portfolios when stocks plunge, broke down last year, as bonds were not boring at all.  Inflation is kryptonite to bonds, but as it abates, we could see a nice rebound in bond markets as well.  Indeed, some our predicting that bonds could even outperform stocks this year. Even cash alternatives are now paying 3-5%.

If things are looking up for both stocks and bonds in 2023, this could be a happy new year for investors, offsetting last year’s trifecta of pain.

Disclosure

The opinions expressed above should not be construed as investment advice. This commentary is not tailored to specific investment objectives. Reliance on this information for the purpose of buying the securities to which this information relates may expose a person to significant risk. The information contained in this article is not intended to make any offer, inducement, invitation or commitment to purchase, subscribe to, provide or sell any securities, service or product or to provide any recommendations on which one should rely for financial, securities, investment or other advice or to take any decision. Readers are encouraged to seek individual advice from their personal, financial, legal and other advisers before making any investment or financial decisions or purchasing any financial, securities or investment related service or product. Information provided, whether charts or any other statements regarding market, real estate or other financial information, is obtained from sources, which we and our suppliers believe reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Nothing in this commentary should be interpreted to state or imply that past results are an indication of future performance.

About

EQM Indexes LLC is a woman-owned firm dedicated to creating and supporting innovative indexes that track growth industries and emerging investment themes. Co-founded by Jane Edmondson, a former Institutional Portfolio Manager with more than 25 years in the investment industry.

Disclosure

The information provided on this page is for illustrative purposes only and is not intended to serve as investment advice. The information provided is as of particular time and subject to change at any time without notice.

It is not possible to invest directly in an index. Exposure to an asset class represented by an index is available through investable instruments based on that index. EQM Indexes does not sponsor, endorse, sell, promote or manage any investment fund or other investment vehicle that is offered by third parties and that seeks to provide an investment return based on the performance of any index. EQM Indexes Indices makes no assurance that investment products based on the Index will accurately track index performance or provide positive investment returns. EQM Indexes is not an investment advisor, and makes no representation regarding the advisability of investing in any such investment fund or other investment vehicle. A decision to invest in any such investment fund or other investment vehicle should not be made in reliance on any of the statements set forth in this article. Prospective investors are advised to make an investment in any such fund or other vehicle only after carefully considering the risks associated with investing in such funds, as detailed in an offering memorandum or similar document that is prepared by or on behalf of the issuer of the investment fund or other vehicle. Inclusion of a security within an index is not a recommendation by EQM Indexes to buy, sell, or hold such security, nor is it considered to be investment advice.