The Stock Market – A Lookback At 2022 and What May Be In Store for 2023

It may seem like an understatement to say that 2022 was an unpleasant year in the stock market when the total return on the S&P500 was a negative 18.1%, but as down markets go, there have been far worse. Remember 2008 when the index declined a whopping 36.5%?

More dramatic was last year’s dismal performance of the Treasury market that fell a monstrous 12.7%, the worst showing in its recorded history. It’s rare for both stocks and bonds to have negative returns in the same year, and I’ve seen cited that it’s the first time in over 150 years that both indices were down double digits. All that warrants a look at the circumstances in 2022 and then a look forward.  

After more than a decade of low inflation that for years bordered on deflation, both in the U.S. and in most of the developed world, there was a reversal early last year. The spike in inflation (globally) was largely the result of exogenous forces surrounding the COVID pandemic—easy money policies (Remember the PPP and then the second PPP?), supply chain disruptions that resulted in massive shortages of essential goods around the world, China’s zero-COVID policy that shut down the world’s largest manufacturer and exporter, and finally, the high personal savings rate accumulated by Americans during the pandemic. Russia’s invasion of Ukraine, a primary exporter of grains and oils to the Middle East and Africa, as well as to the U.S., was, in a way, the tipping point that resulted in major price increases for wholesale and retail food products globally. When consumers finally started to spend, there was a paucity of supply for the reasons noted above, and the definition of inflation—too much money chasing too few goods—worked in spades.

The Federal Reserve, in response to soaring inflation, rightly took aggressive action, raising short term interest rates seven times in the span of ten months, from near zero (.08% in March) to 4.33% by yearend. The corollary to rising interest rates is falling bond prices, which was exacerbated by the near zero level of rates as a starting point. Rising interest rates also portend the possibility of a recession, with fallout impact deleterious to employment, corporate earnings and thus stock prices, so no wonder the stock market sold off.

With that as backdrop, what can we look forward to in 2023? While the Federal Reserve has given every indication that it will not take its eye off the all-important issue of inflation, the evidence is growing that prices are moderating on both the wholesale and retail level. This is true in large measure because the disruptions in the global supply chain have been resolved. Interest rates, at the short end of the market, will likely go higher, but at the longer end of the market, they are down from their highs in October, which tells us that the bond market is sanguine about the long term prospects for inflation. And while an inverted yield curve (when short term rates are higher than rates on long maturities, as we have today), is often considered a harbinger of recession, an actual recession is so far proving elusive. Unemployment remains very low—at 3.5%%--despite headline news that a number of technology companies are announcing layoffs. Labor is in short supply in this country, the result of both “the great resignation” following the onset of COVID and an immigration policy that is woefully short of what is needed for entry level employees. Corporations are finding it necessary to increase wages, part of a pattern that has been unfolding for a number of years, particularly with regard to the minimum wage. While some would argue that rising wages are inflationary, I see it differently. The burden of adequate compensation for employees should fall to the private sector, rather than in the domain of Government in the form of welfare support.

Bear markets—defined as a period in which the stock market falls 20% or more—are not universally predictive of recessions. There are far more bear markets than there are recessions. That being said, should the U.S. economy enter a recession this year, it will be nothing like the 2008 catastrophe that brought the global banking system to the brink of insolvency. Today, both consumer and corporate balance sheets are healthy, and, as mentioned above, the country is at full employment. While corporate earnings may still come under pressure in the months ahead, they are a lagging, not a leading indicator, of economic performance. It’s true that mortgage rates have risen markedly, but they are only back to where they were before the financial crisis in 2008. For half a century before then, mortgage rates ranged mostly from 7% to 10%, except in the late 1970s/early 1980s, when inflation reached 13% and mortgage rates rose to as high at 18%. The current sticker shock is based on an abnormally low rate for the last dozen years. Now that bond yields have returned to a more normalized level, so should mortgage rates.

It's important to keep in mind that the stock market is a leading indicator of economic activity. It prices what it sees in the future; it does not look in the rear view mirror. In the last seventy-five years, i.e. the post-World War II era, there have been only two occasions when the S&P500 declined in back to back years. One was the two-year period of 1973/1974, when the quadrupling of the price of oil brought crippling inflation and a prolonged sixteen-month recession. The second was in 2000/2002 when the dot.com bubble burst, following five consecutive years of torrid stock market returns. While the ensuing recession was relatively mild, it took time to wring out the excess market valuation.

There are stock market prognosticators galore and I don’t consider myself to be one. However, I’m finding plenty of green shoots in the fertile soil of economics, earnings potential and valuation, particularly in mid- and small-cap stocks.

There is an saying, attributed to one Yale Hirsch, whose claim to fame is the Stock Trader’s Almanac, first published in 1967 (and continued to this day by his son, Jeffrey Hirsch)—a brilliant spiral bound calendar brimming with fascinating and useful data about the stock market. I leave you with his adage in reference to what is dubbed the January Barometer. “As goes January, so goes the rest of the year.” Looking good so far, but we still have a few days to go.

Happy New Year!