Fourth Quarter 2022 Market and Economic Review

With a new year fresh in the making, we’re taking this opportunity to also offer a new approach to our quarterly analysis. Previously in this space, we’ve offered mostly a high-level review of both domestic and global market conditions and the economic influences that created them. Going forward, we will still provide a brief recap of the quarter but will spend more time offering some deeper analysis of what these conditions mean to our clients. What are the potential pitfalls and risks? And where are the opportunities?

The Quarter Recap

The fourth quarter of 2022 was a bit of a roller coaster with some ups and downs. After a string of 75 basis point rate increases by the U.S. Federal Reserve and poor Q3 markets returns, October markets turned positive as inflation data started to show signs of levelling. Investors believed the Fed may not need to be as aggressive and in turn could avoid a severe recession.

November’s market results sustained upward momentum as many earnings reports rolled in with better-than-expected figures. Optimism was further enhanced by an apparent easing of rate increases by the Fed as the increase in December was announced at just 50 basis points.

The roller coaster went sharply down from mid-December through the end of the quarter as Federal Reserve Chairman, Jerome Powell, held firm in his comments that the Fed was determined to drive the inflation rates down to 2 percent. And though the December rate increase was lower, Powell added similar increases were still on the table for the next several months.

The fear among some economists is that the rate of inflation is showing strong signs of returning to a healthy state and that additional interest rate increases are not needed as the most recent increases still have not had a chance to fully impact the economy. Inflation peaked in June of 2022 at just over 9 percent. Since then, the inflation rate has shown steady declines down to just over 7 percent by the end of November. Opponents of continued rate increases from the Fed fear that December’s inflation rate will be closer to 4 percent with January and February continuing the slide down to 2 and 1 percent respectively. If correct, the December rate hike – and any subsequent rate hikes – will just increase the economic pain and further delay its recovery.

Globally, the U.S. is in a stronger economic situation than other developed countries. Europe is getting hit much harder economically due to the war between Ukraine and Russia which is causing significant energy shortages with higher costs across the continent.

China’s banking system was already enduring struggles, and their real estate market has been mostly stagnant since the outbreak of Covid. Now the country is having to manage significant civil unrest in response to the government’s hardline Covid policies plus new outbreaks are overwhelming their hospitals.

The Silver Linings and Things to Avoid

For all the reasons discussed above, the entire world is living in a slow-growth environment. In such situations, stocks and investments that rely upon a company’s growth, and don’t pay a dividend, typically perform poorly in portfolios. Such is definitely the case with tech stocks, which is why the NASDAQ has been one of the worst-performing markets over the past year.

Conversely, energy stocks (at least in the U.S.) are mostly up over the same period. Why? Oil prices didn’t fall as much as initially expected at the onset of the current inflationary cycle. There is a good supply and solid demand that are keeping prices mostly elevated. Thus, investors holding these stocks are being compensated even through the current hot inflationary period.

What was a very nice investment option less than one year ago (and for many years prior), is now one of the worst-performing sectors – real estate. Because the increasing interest rates are flowing straight through this industry, it’s suppressing people’s desire to move and buy homes or make commercial property investments. Investors who would normally consider real estate investment trusts (REITs) are finding better returns with treasury bonds.

In the global investment market, there should eventually be some opportunities throughout Europe once the war between Russia and Ukraine finds some resolution. Though it may be years down the road, there will be significant infrastructure rebuilding requirements in Ukraine, and the real estate market should improve across the continent, as well. And virtually all of these countries have learned a hard lesson in being overly dependent upon Russia for energy resources. They will be anxious to correct those dependencies and avoid a future explosion of electricity prices that have risen 600 percent this year in some places.

One investor group that should benefit from the interest rate increases is those that rely in part on their investments to generate income and regular cash flow. With the risk-free rate (2-yr U.S. Treasury) increasing from 0.77 percent to 4.41 percent in just one year, the income portion of such portfolios should be much more productive going forward.

There’s no doubt that navigating an inflationary cycle can be challenging but in some circumstances, it can become possible to meet return goals with lower overall risk after inflation settles down and rate increases have subsided. For 2023, expect continued volatility in the investment market. Traditionally, with such volatility, there are opportunities to take advantage of the cycle changes – which is precisely what we will be watching for on your behalf. We know why we are where we are; so, we are staying alert and taking advantage of those opportunities as they present themselves.