Dear Friends,
2022 was a year that we entered into hopeful for a “return to normal” after the Covid years of 2020 and 2021. It was anything but normal; marked by a number of extraordinary “once every 20 to 40 years” events and circumstances.
- Russia’s invasion of Ukraine in February was a horrible way to start the year. The economic impacts were massive…but pale in comparison to the suffering and inhumanity of war.
- Inflation touched 40-year highs with the CPI reaching almost 10% and the price of many essential items (gasoline, food, and shelter) going up much more than that.
- Interest rates rose the most over the shortest period of time in our history as the Fed funds rate went from barely above zero to over 4%. Just one example of the impact: 30-year mortgage rates went from around 3% to over 7% in about six months.
Each of the items noted above had a significant negative impact on the financial markets. The stock market was down almost 20% and the bond market was down 13% for the year. The bond market performance was the worst in recorded history, and it is virtually unprecedented for both the stock and bond markets to be down that much in the same year. Speculative assets such as cryptocurrencies, NFTs, and meme stocks got crushed, and even the stocks of many large, well-known companies (Tesla, Peloton, many others) were down more than 60% for the year. Asset prices across the board were reset to reflect an inflationary, higher interest rate environment.
What are some of the takeaways and lessons learned from 2022?
- Active, professional investment management can make a big difference. The trades we made in the second half of 2021 helped our clients avoid the worst of the carnage in markets in 2022 (shifting towards value vs. growth stocks, shifting towards short term vs. intermediate or long-term bonds, and utilizing liquid alternative funds which outperformed both stocks and bonds last year).
- The importance of cash reserves, especially for retirees, was underscored in 2022. Having to sell assets to cover expenses when their values are down is not a winning proposition.
- Diversification across asset classes and an emphasis on quality is your best bet for capital preservation in difficult markets.
- “Buyer beware” of speculative assets that lack fundamentals such as revenues, profits, and cash flow. One should only “invest” capital in those assets that you can afford to lose.
What’s the outlook for 2023?
Although we enter the year with a fair amount of uncertainty, we are cautiously optimistic. As we write this, the S&P 500 is about 20% off its highs. While it is certainly conceivable that stocks go lower while interest rates continue to go up over the next couple of quarters and as the economy and corporate profits decelerate or decline, the rate of inflation appears to be declining and we are much closer to peak interest rates than we were six months ago. Peak interest rates should be positive for the stock market. Similarly, we believe that most, but not all, of the damage has been done in the bond market. While bond prices may continue to decline in the face of higher rates, their higher yields have made investing in bonds more attractive now than it’s been in years. All in all, we can’t predict the timing but we are confident that the U.S. economy and the companies that we’re investing in will weather the storm and go on to greater heights in the next cycle.
Last of all, we want to thank all of our friends and especially our clients for their support and encouragement through a difficult year. We are super fortunate to have clients who believe in our disciplined, long-term investment strategy, and we’re proud to say that we did not have a single client who panicked during the year. We appreciate that!
Happy New Year and please let us know what we can do for you.
Matt and Andrew