November 22, 2022 | Victoria Bogner, CFP®, CFA, AIF®
It’s hard to believe that 2022 is nearly over. In some ways, it went by in a blink. In other ways, it feels like we’ve been stuck in the year 2022 for ages. When it comes to how the market has behaved, I’ve experienced the latter.
As of this writing, the S&P 500 is down over 17%, the Nasdaq is down over 29%, and even the US Aggregate Bond Index is down nearly 14%. Gold, a popular hedge against inflation, is down over 5% this year and even TIPS (Treasury Inflation Protected Strips) are down 12.5%. What worked in 2022 were commodities, which consists of the raw materials that are used to create the products that we buy. The Bloomberg Commodity Index is up 18% so far this year with energy being the biggest positive component. Beyond that, the year has been full of red.
Here’s a big question on investors’ minds: are we in a recession right now?
The superficial definition of a recession is two back-to-back quarters of negative GDP growth, which actually happened in the first two quarters of this year. But in the second half of 2022, GDP has increased by 2.6%. Using a more nuanced definition of recession that involves looking at several different indicators, our opinion is that we aren’t yet in a recession that matters to the overall economy and the markets at large. However, that will probably change in 2023.
We do have some positives going for the economy. First, after months of inflation marching ever higher, the October inflation report showed a different picture. Energy inflation has come down the past four months, food inflation is starting to cool off, and most importantly, core goods are showing signs of disinflation thanks to the unclogging of supply chains and lower consumer demand. Used car prices started to fall as well. If this continues, the Federal Reserve has good reason to slow down their interest rate hikes.
On the negative side, we’re seeing a tick up in unemployment, consumer sentiment that’s in the dumps, and earnings growth at its lowest level since 2020. If earnings continue to decline, that will send stock valuations falling in the short term.
Back to the issue of rate hikes, the Federal Reserve has made raising rates their primary tool to combat inflation. The jury is still out on whether this tactic works; the past two years have been a grand financial experiment in how to overcome a pandemic without the economy falling to pieces. Just as TARP in 2008 is still debated today, this will continue to be an economist’s argument for decades to come.
In any case, raising rates has had the consequence of sinking fixed rate bond prices, creating a conundrum that investors haven’t had to face in over 40 years. How does one invest when both stocks AND bonds are losing money?
For our managed accounts, the answer has been two-fold. First, we never time the market. That’s been shown in multiple studies to be an exercise in futility. However, we can adjust to mitigate risk. We invested in floating rate bond funds and senior loan bond funds, which held up much better than fixed rate bonds in a rising rate environment. We also employed buffer ETFs. These allow investors to participate in the upside of the market up to a cap but mitigate some of the downside risk. In this way, we can stay invested in the stock market and get some downside protection at the same time.
As we head into 2023, our view is that a recession is likely in the back half of next year. If inflation continues to trend down and the Fed slows their rate hike agenda, there’s a good chance it will be a mild one. If inflation continues to be a problem and we start to see unemployment jump, things could get much rockier. But avoiding recession altogether is becoming more unlikely.
Remember that simply because the economy does poorly, it doesn’t always stand to reason that the stock market will follow suit. In fact, historically the stock market bottomed out 6 months before the economy because the stock market is always looking ahead. If recession takes hold in the 4th quarter of 2023, the market could bottom in June. A key thing to remember as an investor is not to wait until the economy looks better to invest. Likely, the market will have bottomed long since. A better strategy is to stay the course, invest cash while the market is on sale, and don’t let the news (or your emotions) dictate your investment strategy.
-Victoria Bogner, CFP®, CFA®, AIF®
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Disclaimers and Notes
The Bloomberg U.S. Agg Total Return Value Unhedged, also known as “Bloomberg U.S. Aggregate Bond Index,” is a broad-based flagship benchmark that measure the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate pass-throughs), ABS and CMBS (agency and non-agency).
The Bloomberg Commodity Indices (BCOM) comprise families of investable benchmarks and systematic strategies designed to provide exposure to a broad universe of physical commodities, with no single commodity or commodity sector dominating the index. It focuses on market liquidity and a capping mechanism constraining individual sectors and preserving the balance over time.
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