2022 will go down as one of the worst for investors. As we approach the third year of living with and adapting to Covid-19, we are reminded of Vladimir Lenin’s statement that “There are decades where nothing happens; and there are weeks where decades happen.” The pace of change has been and remains high.
We will also remember 2022 for its return to the most normal state of life since the Covid-19 pandemic began three years ago. Our team returned to the office full time. Each of us enjoyed gatherings with friends in increasing frequency as masks came off and it became apparent that past exposures to the virus and vaccination were reducing transmission and the impact of infection. For that, we are thankful.
The unpredictability of this year—in fact, the past three years—has reinforced our longstanding belief that wealth management should be based on strategy that acknowledges that the future is unknowable. While forecasts are useful and entertaining, the prudent person understands they must manage the consequences of any possible outcome. A good financial strategy should play both offense and defense, attempting to capture the opportunities that present themselves while preserving the ability to meet goals and cash flow needs both today and in the future.
In this blog, we will discuss the major trends affecting markets in 2022 in brief. We will talk about the market outcomes, and review some of the things that did work in 2022. We’ll discuss some of the things that may affect 2023.
2022 In Brief
2022 started with Covid-19 fears seemed to be receding somewhat as people gathered and masks were left home. Markets had rallied in 2021 with the S&P 500 up 28.7% [YCHARTS] as the economy resumed ‘business as usual’ and money from Covid stimulus helped to push up asset prices. Inflation was an issue, but the Fed described it as “transitory” and held the Federal Funds Rate at 0.25% at the end of 2021.1
Then February, Russia invaded Ukraine, causing energy and food prices around the world to spike and accelerating fears that threats to global trade might reverse decades of falling prices if the world shifts from globalization to decoupling. Housing costs, another large component of inflation measurement, rose as both home prices and rents increased.
Inflation reached 8.2% year-over-year this fall, the highest level in four decades.1 (We encourage you to read our piece “Taco Inflation” (Taco Inflation – Kreitler Financial) if you have not already.) The Federal Reserve was no longer complacent that inflation would be ‘transitory’ and in March [Federal Reserve.Gov] they began to raise interest rates. By the end of 2022, rates rose from 0.25% to 4.5%.1
Interest rates could be thought of as the price of money. One of our favorite sayings is that “When money is free, people do dumb things with money.” If borrowing has no cost, business ideas may look better than they really are. Add a significant expense associated with paying for money borrowed and they may no longer work. As a result, rate changes tend to cause investors to reprice many assets.
Another major price in the world is the value of the dollar versus other currencies. In 2022, the dollar as measured by the U.S. Dollar Index (DXY) jumped 8.2%.1 This provided a headwind for investments denominated in other currencies such as foreign stocks. It may have helped to alleviate some inflation on goods purchased with dollars to be imported to the US from other countries.
Impact on Markets
The most direct impact of interest rates changes is on the price of bonds. Rising interest rates cause existing bond prices to fall because newly issued bonds pay more income than the old bond with the lower rate. Since the 1980s the general trend of rates has been downward, so bond prices had a tailwind behind them. them. For 2022, the U.S. bond market (Bloomberg U.S. Aggregate Index) declined -13.0%, its worst year since 1977.2
US Stocks had a difficult year, as well. At -18.1%, the S&P 500 experienced its worst year since 2008. The tech-heavy NASDAQ index fell about 33% as once.
For many investors, the biggest frustration may have been that both stocks and bonds fell in value together. Bonds and stocks often, but not always, move opposite one another. When this relationship works, it can provide a nice element of diversification to an overall portfolio and help to reduce volatility. In 2022, this did not work. A balanced portfolio of 60% U.S. stocks and 40% U.S. bonds returned -16%, the worst return since 2008, and the third worst return since 1950.2
In one important regard, 2022 was completely normal. The possibility of down markets like 2022 is always present and dealing with this volatility is the price investors pay to attain the long-term returns offered by stocks and other long-term investments.
Thoughts on What Worked
Our portfolios are customized to the individual client for their goals, tax situations, and other factors. This makes it impossible to comment specifically on performance in a newsletter. However, several themes played out across our portfolios this past year fairly consistently. While individual results will vary, we feel it worth commenting on them in general.
2022 was a year that battletested financial plans and the portfolios that supported them. Our process anticipates that markets are always volatile, and client goals need to be met whether markets experience good or bad returns. We emphasize liquidity management to address expected portfolio distributions like retirement distributions. We believe this approach pays off most when markets stumble such as they did in 2022. We will continue to review financial plans with you, our valued clients, on a regular basis to ensure this continues.
Within bonds, we have been concerned for several years that ultra-low interest rates were not adequately compensating for the risk that rising interest rates could adversely affect investors. Long term bond prices are affected much more than short term bonds by changes in interest rates. While the overall bond market lost 13%, long term bonds lost a hair raising -27% in 2022.1 In our portfolios, we have maintained a tilt toward shorter duration bonds, which helped to mitigate the impact of interest rate changes.
Within stocks, we have for some time been concerned with the concentration of a small number of big technology companies dominating the overall market indexes. Big tech had a difficult year; for example, Meta and Tesla each lost approximately 64% in 2022. We have generally leaned portfolios away from this big tech market concentration, adding a tilt away from growth and toward value companies to help diversify risk among different types of companies.
In portfolios holding direct participation real estate, that asset class provided positive returns in a year where little else did. Commercial real estate was up 8.7% for the year 2022 as measured by the National Council of Real Estate Investment Fiduciaries.4 Even in years where both stocks and bonds fall, diversification may provide benefits.
Finally, we often remark that many of our best decisions have been the opportunities we chose not to invest in. One of our fundamental biases is that we do not like to invest in something that does not have an inherent reason for making money. In that vein we are grateful that we have no investments in cryptocurrencies in our client portfolios. Cryptocurrencies stumbled badly in 2022, revealing them for the speculative investments they are. Bitcoin, to pick one, fell about 65% as measured by the NYSE Bitcoin Index.4 Moreover, users of unregulated crypto exchanges like FTX may have lost their entire holdings due to fraud.
Looking forward
In a year full of surprises, it is somewhat foolish to offer any predictions on what might unfold going forward. Instead, we will take this opportunity to reinforce the importance of strategy. As global events continue to unfold around us, we need to remember that market volatility is and always will be present. In this regard, 2022 was completely normal.
It is human nature to take what just happened and project it into the future. There are concerns of a recession if the Fed raises interest rates too far. There is speculation about inflation and whether it will be more persistent than many hope. There is always the risk of an unforeseen event such as Russia’s invasion of Ukraine a year ago. Having a financial strategy means accept that these things could happen, and that we need to be able to get through them without upsetting portfolios. To realize the markets long-term returns, compounding at 10% per year for stocks. (S&P500 20 years ending 12/31/2022 9.7% annualized return; 1928-2022 9.6% annualized)1, investors must be willing to tolerate these inevitable market swings.
The decline in stock prices has made them significantly cheaper than they were at the beginning of 2022. A 10-year Treasury bond now pays 3.8% as opposed to its 1.5% rate one year ago.1 Both asset classes now represent a better value than they did at the beginning of 2022, which historically has meant better future returns.
Markets are forward-looking with investors trying to bet on the future. Stock markets typically lead the economy, declining before a recession officially begins and then rallying before the news turns good again. While they could decline further, our sense is that markets have already absorbed a lot of bad news and economic changes. With that said, we continue to monitor the market environment and remain flexible but disciplined in our approach to achieving clients’ long-term goals.
Other Financial Notes
The midterm election results delivered a divided government. This makes it likely there will be no major policy changes until after the 2024 election. Historically markets have liked gridlock in Washington because it slows the rate of changes to policy, making business and tax decisions more predictable.
In the waning hours of 2022, the departing Congress passed the Secure 2.0 Act. This made changes to contribution limits for retirement plans, increased ages for Required Minimum Distributions (RMDs) for some individuals not already taking them, among other changes. We will cover the planning opportunities presented by these changes in future updates.
Inflation caused many things to become more expensive last year, but it also caused significant changes to things tied to it. Social security benefits received the largest increase in 4 decades at 8.7% COLA in 2023. The standard deduction for filing taxes increased to $27,700 (Married Filing Jointly), $20,800 (Head of Household), $13,850 (Single/Married Filing Separately). The estate tax exemption increased to $12.92 million per taxpayer in 2023 and the annual gift exclusion increased to $17,000** per taxpayer.3
We encourage you to call us if you have questions.
- YCharts, 2. JPM Guide to Markets 1Q 2023, 3. Broadridge Investor Communication Solutions, Inc, 4. Envestnet Tamarac