2022 was a difficult year for most investors no matter which investments you owned. The S & P 500 ended the year down more than 19%. The bond market had its worst performance in over 50 years. Persistent inflation, Federal Reserve rate hikes pointing toward a risk of recession, geopolitical uncertainty, and the Ukraine war added tremendous complexities to life after the pandemic. What more could investors absorb in one year. The important thing to note is that it was one year, not five or even a decade. This period feels longer because markets didn’t bounce back quickly.
Since inflation’s peak at 9.1% in June 2022, inflation has since declined to 6.5% through December according to the Consumer Price Index. This has created optimism for investors which is reflected in your fourth quarter investment statements. Although this is good news, the most recent data points to more economic downturns. At the November Schwab Impact conference Liz Ann Sonders, Managing Director, Chief Investment Strategist at Charles Schwab & Co., commented that we may see a rolling sector recession in 2023. This means various industries could move in and out of recession throughout the year.
The Federal Reserve has an extremely difficult job. The most recent jobless claims, consumer spending and the unemployment rate at 3.5% might tell us that the economy is in good shape. However, corporations have a different view when measuring manufacturing sentiment, employee hours worked, and business confidence. Businesses are showing a slowdown. This disconnect is showing an easing of inflation yet there are plenty of economic concerns to work through before the markets can move out of bear territory. Don’t be surprised by layoffs or reducing employee hours by companies as we move through the first half of the year.
The global economy may potentially feel China’s reopening, which could be good for commodities, particularly copper, but it could also add some inflationary pressures with a new wave of consumer demand. The Federal Reserve is walking a tight rope and rate hikes may be with us a bit longer. The bond market has seen some upsides in recent weeks; however, we believe that with the Federal Reserve still hiking rates shorter-term high-quality bonds and even money markets earning north of 4.3% are good places for now. We will continue to monitor interest rates and inflation.
In 2022 white papers were published explaining why a balanced portfolio of 60% equities and 40% bonds no longer works. We would point out that one year of underperformance is not reason to dismantle the balanced portfolio allocation. Bonds today are at very depressed prices making for very attractive entry points. Think about what happened in 2022. Interest rates were near zero and the Federal Reserve aggressively raised rates which contributed to lackluster bond performance. It was as if someone hit the reset button. We believe bonds still make sense in a diversified portfolio. Although they didn’t provide stability in 2022, we are beginning to see a more normalized bond market.
The economic data is mixed as to whether we are in a recession, or if we will experience a soft landing. We all have heard the coined phrase, “We have been through this before.” It is not just a saying - history shows that we have experienced it and we have recovered.
It is hard to see through a storm when you are in it, but you know it will eventually clear. When you are accumulating money, it is easier to sometimes accept volatility because time is in your favor. During retirement you may question whether it is the right time to be in the market. Sifting through all the information and trying to apply it to what ifs can be an emotional thought process.
We believe investors should not run away from market volatility but instead maintain composure and embrace it given that higher volatility has historically created significant long-term investment opportunities. As markets have historically rebounded from the deepest selloffs, portfolios need some exposure to equities as sectors rotate into better times.
We write about the importance of diversification because it delivers the best outcomes over time. A diversified portfolio allows you to play offense and defense at the same time. Portfolio allocation can give you peace of mind knowing that you have less exposure to equities (defense).
As we move through the 2023 first quarter, we will continue to monitor your portfolio allocation. We are in this together and we will guide you through to the brighter days ahead. We welcome your questions and look forward to our next conversation.
Thomas L. Menzel, CFP® Laura Biermann, CFP®President Vice President