First, we would like to wish you and your family a happy and healthy New Year! We hope you were able to close out 2022 surrounded by friends and family.
As the first week of 2023 comes to an end, it’s nice to see some green on our screens for once. 2022 was a difficult year (to say the least) with the S&P 500, Dow 30 and Nasdaq Indices returning -18.11, -8.78 and -33.1% respectively.
Bonds, which generally act as a portfolio ballast during times of stock market volatility woefully under-performed as well with the Barclays U.S. Aggregate Bond Index returning -13.01%.
I believe we are all feeling a little beaten up from last year’s consistent string of negative economic and sociopolitical news that we are figuratively limping into 2023.
As difficult as last year was – there are reasons to maintain some optimism for 2023 as more often than not, bad market years are followed by good ones.
We reviewed all calendar years following negative S&P 500 Index performance and found that the S&P 500 Index had back-to-back negative years in only four instances since 1930. Those occasions occurred during the Great Depression, World War II, the 1970s, and the dot.com bubble years —periods perhaps more economically dismal than what we face today. So, while history never repeats itself, it does often rhyme.
Furthermore, since 1950, there have been 18 mid-term election years, and in each instance, the S&P 500 Index has been higher in the subsequent year. Not only have stocks been positive in those cases, but the Index has been higher by 14.7% on average. Stocks also typically perform well when two parties share power in Washington, D.C., and November’s election ushered in a Republican majority in the House, balancing the power once again.
On the inflation front (the markets current #1 enemy), we know it peaked in June of last year (2022). Since then, we have seen consecutive declining core CPI/PPI rates dropping sharply – evidencing the Fed’s interest rate hiking campaign is working and slowing the economy. Although slowing, we do expect another 50-basis point interest rate increase on February 1st and we do expect the U.S. economy to tip into a mild recession later this year.
This being the case, corporate profit growth is expected to be flat, and consumer spending growth should also slow. Meanwhile, deteriorating U.S. relations with China and the ongoing Russia-Ukraine conflict add risks for the economy and markets. But these challenges are offset by still-strong consumer and corporate balance sheets and the likelihood that the Federal Reserve will stop hiking interest rates in the first half of 2023, which may help give stock prices a boost.
Not to mention, this morning’s Nonfarm payroll report reflects a 3.5% unemployment rate which is one of the lowest rates in history. The labor market is extremely tight and anyone that wants to work can find a job. This is great news but could continue to be problematic as it fuels wage inflation -something the Fed wants to keep in check.
The overall market decline in 2022 has lowered stock valuations relative to their earnings, suggesting many of the above concerns may have already been priced in. This leads us to believe that 2023 is unlikely to be a repeat of the year just passed. Historically, the S&P 500 index has traded at a price to earnings ratio of roughly 16 (P/E ratios are one way to value the overall market). Currently, the Index is trading at a P/E of roughly 19 and at the peak of the market in 2021 it was trading at a P/E of roughly 34.
It appears that much of the pandemic froth has been taken out of the market and one could say that the market may be trading at fair value again. Making stocks valuations once again appealing for long term investors. Yes, there are still pockets of frothy valuations within markets but largely stock prices are enticing.
Tactically, regarding portfolio asset allocation, we are keeping a bit more cash on the sidelines for a rainy day (as opposed to our historical norm) and are purchasing individual bonds (investment grade corporate, agency/treasuries) as opportunity continues to present themselves as yields may start to trend lower soon. Given the utter unpredictability of these markets we feel this is the best course of action.
In closing, we would be foolish to think 2023 will be smooth sailing -in all likelihood we will continue to see 2022 like volatility for the first two quarters of this year. We are clear eyed on this and will continue to operate with a heightened sense for risk mitigation but being mindful of opportunity.
We wish you and your family a great Friday evening, and an enjoyable weekend.
As always, please reach out to us with any questions or comments you may have regarding your specific situation.
Jaran C. Day, Chief Investment Officer
Griffin Dalrymple, CFP®, Chief Strategy Officer