Annual Market Review 2022

From the Desk of Mike Ruff, Portfolio Manager

The year 2022 may best be described by one term: Fed-flation. The economies of the United States and the world were influenced by rising inflation, its causes, and the policies aimed at curtailing it. While inflationary pressures began to mount in 2021, they were exacerbated by unprecedented global government economic stimulus followed by the Fed under appreciating the inflationary impact of unprecedented economic stimulus; continuing supply chain issues; the ongoing effects of the COVID-19 pandemic; and the Russian invasion of Ukraine.

The Fed underestimating impact from huge government stimulus will be remembered as one of the largest misses by the US central bank in history.  Most importantly, Fed officials didn’t foresee the impact the Russian invasion of Ukraine would have on world trade in energy, food commodities, and resources such as natural gas and crude oil. The International Monetary Fund expects worldwide inflation to hit 8.8%, the highest rate since 1996. In response, the Federal Reserve began the most aggressive interest-rate hike cycle in more than 15 years.

While the equity & bond markets and US economy are not one-and-the-same, they are closely linked.  So it is no surprise that near record inflation & the Fed’s interest rate decisions also impacted the equity & bond markets, both at home and abroad. Several equity market sectors that had led the bull market surge since 2008 suffered notable pullbacks. Information technology and communication services ended up as two of the worst performing sectors in 2022. Retail stocks also took a tumble as inflation drove up nondiscretionary items like food and energy, leaving less for consumers to spend on discretionary products and services. An additional tail-wind for inflation plaguing retailers was rising costs associated with products, services, and labor.

Given bond prices move in the opposite direction of interest rates, its no surprise that the Fed’s aggressive interest rate increases led to one of the worst bond market performance periods in history.  As an example, the 10-yr treasury rate moved from 1.51% at the end of 2021, just twelve months later that same rate was at 3.87% resulting in a -13.01% loss for Bloomberg Aggregate Bond index.  The aggressive interest rate increases were felt in other areas of the economy as well.  For example, the home mortgage market has suffered significantly as higher interest rates have made home buying less affordable leading to one of the steepest declines in new home construction as well as existing home purchases.

Finally, no discussion of market and economic performance for 2022 would be complete without mention of the melt down associated with crypto currencies.  While most of us may be more familiar with the spectacular crash of crypto currency trading firm FTX, actual crypto currencies suffered significant losses over 2022.  Bitcoin (one of the most popular cryptos) suffered a 65% drop in value through 2022, while Ethereum fell by nearly 68%.  The bankruptcy of FTX and the steep decline in nearly all crypto currencies values has left investors concerned for the future of the entire crypto market.  At a minimum, we should expect increased regulation and oversight of the wild west crypto market in 2023.

Eye on the Year Ahead

Changes to the employment picture and the battle against rising inflation will likely continue to dominate much of the economy and investment markets in 2023. Inflation and employment data are vital to future direction of Fed action and ultimately the direction of interest rate changes hence an outsized focus on both data points.  In many ways, 2023 may also be the year of good news is bad news, and bad news is good news.  For example, good employment data (i.e. lower unemployment rate/higher job postings) may push the Fed to continue aggressive rate increases and therefore slow the economy from a hopeful “soft landing”, to a full blown recession. In fact, many large Wall Street banks are calling for a recession in the last half of 2023.  Strangely encouraging, the bad news is good news scenario may already be playing out given 2022 ended, and 2023 began, with announced layoffs in both the technology and banking sectors.  These layoffs could lead to lower demand for goods/services and therefore lower inflation and less need for the Fed to continue its aggressive interest rate increases. At Financial Insights, we remain cautious for the first half of 2023 and hopefully optimistic for the second half.  Watch employment data for insight into inflation and Fed action.