With inflation reaching a four decades’ high and the war in the center of Europe sparking selloffs across all the markets, both the S&P 500 and Barclays U.S. Aggregate Bond Indexes fell over -10% for the first time in history. For most of the year, any rare sparks of hope were few and far between as the S&P 500 had less positive trading days than in any year since 1974. Even though during the fourth quarter both stocks and bonds clawed back some of their losses, all the major market indexes ended the year deep in the red. The S&P 500 Index ended the year at -18.1% after recovering 7.6% of the previous losses during the fourth quarter as the largest holdings of the index heavily impacted the decline. Mid-caps closed the quarter with a 10.8% advance and finished the year down -13.1%. Small-caps, as measured by the Russell 2000 Index, lost -20.5% for the year despite posting a positive 6.2% return for the quarter. The tech-heavy Nasdaq Composite was the only major equity index that did not achieve a positive return during the last quarter and ended the year with the loss of -32.5%. Value stocks outperformed their growth counterparts for the first time since 2016, posting an annual loss of -5.3% vs a -29.4% loss for growth stocks.
Only two of eleven sectors of our domestic economy ended the year with positive returns. The clear winner was the energy sector, which had a gain of 65.4%. Utilities finished 2022 almost flat, adding just 1.6%. All other sectors posted losses for the year, some of them in double digits.
Performance results within the international equity markets were positive for the quarter, but still negative for the year. The MSCI EAFE Index of Developed World Markets was up 17% for the quarter, cutting the previous three quarters’ losses in half.
The fixed income market was not the usual safe haven for investors. In the beginning of the year, short-term interest rates were still near the pandemic-era lows and the 10-Year Treasury yielded 1.46%. The fast rate of tightening imposed by the Federal Reserve brought this yield to 3.62% and nearly every segment of the fixed income market experienced declines, especially bonds with long duration. The Barclay Aggregate Bond Index dropped -13% during the year, posting its worst performance in history.
The latest GDP growth report for the third quarter showed an expansion in our domestic economy after two quarters of contraction. The final reading of GDP annualized growth came in at 3.2%, pushing the economy into a positive territory for the year. This number reflected growth in exports and spending, both by consumers and local and federal governments.
Job growth remained solid, with an average of 272,000 jobs created each month, but cooling slightly in December. The unemployment rate remained unchanged at 3.7% since August, falling to 3.5% during the last month of 2022.
U.S. inflation, almost nonexistent for decades, resurged with a vengeance this year, reaching heights unseen since the early 1980s. The Consumer Price Index reached a 40-year high in June and eased slightly to 7.1% in November. Galloping prices shrank Americans’ inflation-adjusted pay despite high wage growth.
The Federal Reserve’s aggressive action to combat unacceptably high inflation was the story of last year. The Fed raised rates at every meeting in 2022, with the fed funds rate starting the year at .25% and reaching 4.5% by the middle of December. The initial 25 basis point hike in March and the 50 basis point hike in May became more dramatic during the following four meetings when the Fed raised interest rates by a total of 3% in six months. It was the largest 12-month increase in interest rates since 1981, and the FOMC currently projects the rate to reach approximately 5% to 5.5% by the end of 2023. That means a few more hikes in interest rates in early 2023, though likely smaller than we’ve seen in 2022.
As we enter a new year, the cross currents of stubbornly high inflation and the Fed’s tightening will still be the themes of 2023. It would not be a surprise to learn that a recession is coming or already in progress. Market volatility most likely will remain high. However, we think these conditions are heading toward a turning point, which should produce a more favorable outcome for market performance in the year ahead. The ride is likely to start out bumpy, but we think 2023 will ultimately steer in a positive direction as a new expansion and bull market take shape.
Dumont & Blake Investment Advisors, LLC
December 31, 2022