2022 finished with a whimper as the rally in October and November dissipated in December.  Stock markets again retreated for the month as investors are now concerned about a potential global recession in 2023. 

As we exit 2022, investors are assessing the damage of the year and simultaneously looking for signs of recovery for the year ahead.  Consensus expectations are for a weaker economy in 2023 as job strength begins to wane and consumers pull back from their post-COVID recovery spending levels.  Inflation, the biggest story of the year, began to descend from the 40-year high levels in mid-year but remains significantly higher than the long term average.  Earnings estimates still reflect growth in 2023, but the level of expected growth has worsened with many market prognosticators now calling for an earnings decline. 

The bond market faced significant challenges from rising interest rates, and as a result, the aggregate bond market performance was among the worst in history.  The ultra-low income levels seen in 2020 and 2021 are now gone.  The 2-year US Treasury yield was less than 1% a year ago, but investors buying these bonds now are receiving over 4%.  If inflation remains persistent, it may require further rate increases that would act as a headwind for bonds.  However, if we have seen the peak of inflation and inflation continues to decline in 2023, we may be at a level where bonds are attractively priced. 

For the stock market, the only positive sector in 2022 was Energy.  Energy stocks significantly outperformed the market as inflation trends and geopolitical conflicts provided a backdrop of higher oil prices.  Despite oil prices peaking early in the year, and falling in the 2^nd half of the year, Energy stocks retained their momentum through year end. 

The other stark contrast in stocks for 2022 was the performance of value versus growth stocks.  Value stock performance was negative for the year but held up significantly better than their growth counterparts in 2022.  Sectors like Consumer Staples, which are more defensive during times of economic downturn, outperformed growth oriented stocks in technology and consumer discretionary.  Also, stocks that were pandemic darlings, such as Peloton, Teladoc, and Zoom Video, faced precipitous declines in 2022 as business trends shifted and investors were no longer willing to pay astronomical valuations for these companies.   

As we shift to 2023, there are concerns about the economy and trends within company fundamentals and consumer pocketbooks.  While inflation trends were the predominant concern in 2022, and remain a concern as we turn the calendar, the bigger concern among market participants is slowing economic activity with the potential of rolling into a US or global recession.  It is our opinion that a US recession is a higher likelihood now compared to last year, but if we do fall into a recession, it is likely to be quite mild with less economic decline and job loss compared to prior recessions. 

The bond market is more attractive now than it was at this point last year.  The Federal Reserve has raised rates very aggressively, which has pushed current bond yields comparatively higher.  There still may be some headwind from rising interest rates, but our opinion is that we have seen the peak of inflation and believe the Fed is closer to the end than the beginning of rate increases.  As a result, bond investors are receiving higher yield, and if rates stabilize, overall returns would be improved.  However, we would caution investors not to expect a significant short term rebound in bond prices as our opinion is that rates are more likely to stabilize than significantly decline from current levels. 

For the stock market, there are mixed signals.  The job market is likely to be softer in 2023, which could lead to a consumer spending pullback.  If consumers reduce spending, that has a negative influence on corporate earnings.  Over longer periods of time, stocks tend to follow corporate earnings growth.  If earnings decline significantly, it will be difficult for the stock market to be positive.

On the other side, a slowing economy is widely anticipated, and markets tend to be forward looking.  If the US economy slows into a short and mild recession, and corporate earnings do not fall aggressively, then the worst of the stock market decline may already be behind us.  Stocks, while not historically cheap, are below the valuation level at the same time a year ago and relatively in line with 25-year averages.  In the short term, valuation doesn’t provide a lot of analysis on future trends, but what investors pay for stocks is important for long term returns.  In that regard, we are in a better place now than we were a year ago. 

When markets experience a decline like 2022, it is common for investors to question why they own stocks in the first place.  It is important to remember that corrections and bear markets tend to be short but painful while bull markets tend to last longer and provide higher returns.  The risk of years like 2022 is the cost of achieving higher levels of long term returns.

As we enter 2023, our belief is steadfast that having a well-defined investment plan that sets objectives and allocates investments accordingly is the most effective way for investors to achieve the goals for their money.  Diversification between stocks and bonds was not a source of comfort in 2022 as both stock and bond performance were negative.  However, diversifying investments based on a proper level of risk is still the best way to balance safety and asset preservation with growth to offset the negative effects of inflation.  When markets are performing well, it can be easy to overestimate the tolerance for risk.  Conversely, when markets face significant declines, any tolerance for risk can feel difficult.  It is important to balance those scenarios and properly align portfolios to the appropriate balance of risk that fits the proper time horizon for the objectives.