Q4 2022 Insights
2022 was a difficult year for investors. It was also an unusual year. Over the twelve months to December, U.S. equities declined 19% and non-U.S. equities declined 16%. Even the main benchmark of U.S. fixed income¹ provided no safe haven, falling 13% over the course of the year. Notably, in 50 years, 2022 was the only instance in which both equity and bond markets declined in the same calendar year.²
However, there is a silver lining. It was a year of multiple exceptional events that very rarely occur at the same time, or to this degree. Most noticeable was the start of the most aggressive policy rate hike cycle in history by the U.S. Federal Reserve. In response to sticky post-pandemic inflation, which was exacerbated by the shock to energy and food prices resulting from the Russia-Ukraine war, between March and December, the central bank raised the Federal Funds rate from 0.25% to 4.50%. This policy interest rate is not just used to price loans to borrowers, but also to value most asset classes from bonds to equities, where higher rates result in lower implied prices. Additionally, 2022 saw two sharp liquidity crises in critical global funding centers, Japan and the United Kingdom, which amplified volatility in global equity and bond markets.
The combination of events in 2022 was tough, but the market’s “risk-off” reaction was broad, swift, and front-end loaded. In fact, if we take a step back for perspective, the sequence of market drivers illustrates a year of two very different semesters. Remarkably, most of the year’s declines across equities, fixed income, and rates markets, occurred in the first semester with markets reaching the first key low in mid-June (the S&P 500 Index was down 22% year-to-mid-June). Then, after many global asset classes reached a second key low in October (at which point the S&P 500 Index was 2% below its June low), the worst stressors began to moderate (or resolve in some cases), and the second semester staged a robust rebound that has encouragingly continued into the new year.
Despite the negative year-end returns for 2022, most of our clients’ diversified portfolios were, in aggregate, able to perform well and protect on the downside. Sizeable allocations to value stocks, non-U.S. equities, and most importantly lower-duration fixed income all helped soften the blow to portfolio returns. With both equity and bond markets recovering since mid-year, those that remained invested had a chance to quickly recoup some of the earlier declines.
That said, we do not have a crystal ball. While 2023 continues the recovery that began in the second half of 2022, there is no clear indication when markets will fully recover its declines, nor what magnitude of volatility we will experience this year. Already, we are seeing the impact of the Fed’s rate hikes transition from the typical early-stage effects, such as housing and new orders, into later-stage effects on company earnings and employment. Said another way, while uncertainty about inflation, central bank missteps, and geopolitical frictions remains pervasive, we believe we are nearer to the light at the end of the tunnel (and markets tend to recover before the real economy bottoms out). These are the moments when investors must be patient, remain disciplined, tune out the short-term noise, and take advantage of long-term opportunities. We have been in these situations before, and we continue to work hard to make our clients’ portfolios more efficient and better positioned to meet their long-term goals.