This past year has been one of the worst in memory. While large-cap stocks declined dramatically (18-19% depending on the index), 2022 was not their worst year. What makes 2022 so bad is the decline across many asset classes, including bonds. In fact, at one point, the Wall Street Journal said that 2022 was one of the worst years for bonds in history. The chart below provides an overview:
Figure 1: Market Summary
Rising inflation led to the Federal Reserve’s attempts to rein in the surge, and they raised rates the most in history over such a short period (inflation as measured by the CPI vs. the Federal Funds Rate):
Figure 2 Federal Funds Rate vs. CPI
Rising rates generally lead to a repricing of various assets and markets. The threat of high inflation and the Fed’s response which could drive the economy into a recession, led to steep declines in asset values[1]:
Figure 3: Price to Earnings Ratios
The Fed’s response to inflation caused interest rates to increase dramatically as well:
Figure 4: US Treasury Yield Curve
You may note that the most recent yield curve shown above is “inverted,” short-term rates are higher than long-term rates. An inverted yield curve may signal that a recession is near. We think that that possibility is partially priced into equity markets. You can see the close correlation between the five year treasury rate and the decline in the price-to-earnings ratio for the S&P 500:
Figure 5 Five-Year Treasury rate and S&P 500 Price to Earnings Ratio
The video accompanying this blog (see below) discusses other asset classes that performed poorly, including bond funds. Bond funds had a challenging year; the traditional 60/40 model (60% large stocks and 40% bond funds) had an awful year because of the decline in bond prices and large-cap stocks, declining almost as much as the S&P 500 alone:
Figure 6 60/40 Model, S&P 500 and Atlas Model 6
A diversified model (Atlas Model 6) declined somewhat over 9% in 2022, 6-7% less than the 60/40 model and the S&P 500. The Atlas model is much better diversified than the 60/40, and it includes some asset classes that either outperformed in 2022 or were up slightly:
Figure 7 What held up in 2022?
Some key points we can derive from 2022 are:
- Diversified Portfolios may perform better than the 60/40 in the long run
- Diversification does work
- Markets may be more reasonably valued
- Inflation may be diminishing, leading to fewer Fed Funds rate increases.
- Bond yields may remain at levels that enable them to provide decent returns
Our expectations for 2023 and the next few years are:
- Facts suggest investors should focus on what they own and valuations, not how they feel about the world.
- Consistent expectations are for slower economic growth globally
- Slower Inflation (leading to fewer increases in Fed Funds rate)
- Equity Returns may not keep pace with recent past performance.
- Bond Yields will remain at levels that will contribute to return.
- Enhancer Assets will continue to provide proper diversification (beyond the overly simplified 60/40) to manage risk and return.
[1] Source: FactSet, Refinitiv Datastream, Russell Investment Group, Standard & Poor’s, J.P. Morgan Asset Management. All calculations are cumulative total return, including dividends reinvested for the stated period. Since Market Peak represents period from February 19, 2020 to December 31, 2022. Since Market Low represents period from March 23, 2020 to December 31, 2022. Returns are cumulative returns, not annualized. For all time periods, total return is based on Russell style indices except for the large blend category, which is based on the S&P 500 Index. Past performance is not indicative of future returns. The price-to-earnings is a bottom-up calculation based on the most recent index price, divided by consensus estimates for earnings in the next 12 months (NTM) and is provided by FactSet Market Aggregates and J.P. Morgan Asset Management.
Guide to the Markets – U.S. Data are as of December 31, 2022.
