Fourth Quarter Market Summary
The Fed continued to raise rates aggressively during the fourth quarter. Despite the hawkishness, both stock and bond markets posted positive returns as investors focused on inflation slowing. Markets seem to believe that the Fed will slow the pace they are increasing rates and possibly cut the Fed Funds Rate in the second half of 2023.
US stocks gained 7.1% during the fourth quarter, reducing the loss for the year to -19.0%. Value stocks outperformed growth stocks for the quarter. Growth was weighed down by a 54% decline in Tesla and a 26% decline in Amazon.
International stocks were beneficiaries of a weakening US Dollar in the fourth quarter. It was a welcomed trend reversal for US investors invested internationally as the Dollar has been a headwind for many years. International stocks outperformed domestic stocks for the quarter (14.3% vs 7.1%, respectively) and for the year (-16.0% vs -19.0%, respectively).
The 10-year Treasury yield ended the quarter at 3.88% after jumping to 4.25% in October. Short-term bond yields increased as the Fed raised rates twice during the quarter.
Below is a table highlighting various market index returns over the past 3, 12, and 36 months:
2022 was one of the worst years for a balanced portfolio in 50 years. Stocks and bonds were both down double digits and ended the year at what we feel are much more reasonable valuations. 2022 may have ushered in a new investment environment where investors can actually earn something greater than zero for holding cash and can buy short-term Treasuries that yield greater than 4% and the stock market may reward more than just a few companies.
While the Fed is expected to continue to increase interest rates a few more times in 2023, we feel that a repeat of a 13% loss in the bond market is unlikely given inflation is gradually declining. The Fed has stated that they are committed to a “higher for longer” mentality, which means the higher rates may be here for longer than the market is currently predicting. Fixed income is now providing competition to stocks as investors compare an attractive yield to the volatility of stocks.
A few large technology and consumer discretionary stocks have dominated this market for many years. Meta, Apple, Amazon, Tesla, Microsoft, Alphabet, Netflix (MAATMAN) were huge sources of return since 2015. As can be seen below, the MAATMAN stocks returned 24.30% annually since the beginning of 2015, while the S&P 500 Index ex MAATMAN returned only 7.37% over that time.
Source: MSCI, FactSet, AMG Funds
These same stocks that were sources of strength, were big sources of weakness in 2022. The chart on the next page shows that in 2022, MAATMAN stocks were down 44.08% for the year, while the S&P 500 Index ex MAATMAN was down just 10.77% . The S&P 500 was down 18.11%.
Source: MSCI, FactSet, AMG Funds
Even after the big decline in 2022, the longer-term outperformance of MAATMAN has been significant (see the first chart). This really shows that strength of these few stocks and how much they have added to the outperformance of the S&P 500 Index vs other indices.
As we look back on 2022 and forward to 2023, some of the questions we are asking ourselves include:
- Will the higher interest rates persist long enough to create a new market environment with broader market participation from all stocks and sectors, rather than a few stocks dominating the market?
- International equity investing has significantly underperformed the US market over the last decade. However, much of the underperformance can be attributed to the fact they don’t have the MAATMAN stocks and a strengthening dollar over that time. If more sectors have improved market performance, will international stocks reverse the long trend of underperformance?
- If interest rates stay higher for longer, will the financial sector, which has largely not participated in the last decade’s rally, begin to lead the market as it did decades ago?
- Will the Fed be able to orchestrate a soft landing or will higher rates lead to and economic recession?
As we look to position your portfolio for the coming year, these, along with other questions, are driving our decisions. Time will provide each of us the answers, but keeping a long-term outlook and positioning each portfolio for our clients goals will remain a top priority.
If you have any questions or your situation has changed, please give us a call.
JR Geld, CFA, CFP®
Philip E. Huber, Jr, CPA, CFP®
HWA Financial Group
3448 Ellicott Center Dr.
Ellicott City, MD 21043
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