Warren Buffett once said, “Be fearful when others are greedy, and be greedy when others are fearful.”
It is often easier said than done. Particularly during periods of market turbulence like we’re currently living through. When daily moves of 1%-3% in the markets are the norm, it can be difficult to maintain our resolve. The frequency with which we experienced that type of volatility is unusual and can be unsettling. Staying the course becomes difficult but is often the best path forward for investors.
Let’s review what occurred in 2022 and what we expect to happen in 2023.
2022 was a year like few others for several reasons:
- Russia invaded Ukraine on Feb. 24th.
- Inflation rose to the highest level in 40 years.
- The Federal Reserve raised rates seven times, from 0.50% to 4.50%, including four successive 0.75% hikes.
- Many cryptocurrencies fell by 60% or more, invoking panic and failures in related companies.
- The U.S. economy experienced two consecutive quarters of negative GDP growth (Q1 and Q2), which meets the technical definition of recession, although one was never officially declared.
- We had a contentious mid-term election that failed to deliver significant majorities for either political party, likely resulting in gridlock for the next two years.
These events had a significant impact on markets and investor sentiment.
Overall, the markets, measured by the S&P 500, fell more than 28% by October, entering “bear market” territory, finishing the year down 19.44%.
The Barclays Aggregate Bond Index, a proxy for bond performance, was down 13.01%, and the 10-year Treasury, a benchmark rate for banks and mortgages, started 2022 at 1.63%, rose to a high of 4.25%, and closed the year at 3.88%, for a total return of -16.47%.
International equities, measured by the MSCI All Country World ex-U.S.Index, were down 15.57%.3
What to expect in 2023:
Our base case is for the first half of the year to look and feel like last year. Continued uncertainty around government policy, economic conditions, corporate earnings, and rising rates (although we expect the rate hikes in February and March to be smaller than those in 2022) all mean that the markets will be searching for direction.
With tight labor markets and rising wages, it may be difficult for the Fed to achieve its goal of increasing unemployment enough to quickly bring inflation close to its 2% target. That means inflation and rates will likely stay elevated longer than some expect, keeping pressure on stocks and possibly driving the U.S. into a recession. However, we don’t expect it to be long-lasting or severe.
Tight monetary policy may even put continued downward pressure on equities, meaning we could see lower stock prices and corporate earnings in the first half of 2023. If we see new lows or significant drawdowns, just remember that markets have historically bottomed and usually begin a new upward trajectory before recessions end.
While we don’t necessarily expect new lows in the indices, we remain cautious and defensive in client portfolios.
We will keep this defensive posture until we see markets pull back to a level where we are more comfortable adding to stocks or get the “all clear” signal on the upside, with the S&P500 breaking through, and remaining above, its 200-day moving average.
Looking at international markets, a recession may also be in the cards for Europe and parts of Asia; however, there are several reasons the international investing landscape is attractive.
First, foreign equities are trading at a 29% valuation discount to the U.S., the widest margin since 20061, and there are more than five times the number of foreign companies (580) with dividend yields between 3%-6% compared to U.S. companies (110)2. When foreign companies pay dividends, or when their stock prices rise, as the dollar weakens, you are converting that foreign currency into “more dollars” because the exchange rate relative to the U.S. Dollar has changed in your favor.
Secondly, many of the companies headquartered outside of the U.S. are in “old industries” that did not lead the last bull market but may be well positioned to drive the next one: materials, industrials, consumer staples, etc. Unlike the U.S. indices, Technology is the smallest sector in the MSCI All-Country World Index. This index represents the majority of investable companies outside of the U.S.
Third, China is easing its zero-covid policy; while infections are rising, history shows this will be temporary. As people return to work and leisure activities, increasing demand from consumers and increasing manufacturing production for companies to export around the world should help buoy both China’s domestic economy and economies around the world as supply chains continue to ease.
In addition to opportunities in equities around the world, we also believe that there are attractive options in fixed income now, thanks to rate hiking campaigns enacted by the Fed and other Central Banks around the globe. Yields have been driven to attractive levels in several sectors, both in the U.S. and abroad.
What should we do now?
Two questions we get from clients are: “What should we do now?” and “What major changes do we need to make to survive this?”
The question we believe clients should be asking is: “What do we need to do to remain focused on our long-term goals and stop worrying about short-term noise?”
First, reassess your current investment time horizon, risk tolerance, and goals to ensure they align with your current situation and financial plan. If none of these things have changed, then investment portfolios likely don’t require major changes.
If you have a short time horizon or a low tolerance for volatility, consider taking advantage of higher interest rates and allocate more of your portfolio to cash, cash equivalents like CDs, or short-term fixed income.
If you have a longer time horizon and a higher tolerance for volatility, then your allocation should include more stocks, both from the U.S. and overseas. With a well-diversified portfolio focused on high-quality companies, you can weather this storm and emerge in a strong position to pursue your goals.
We do believe that there is a possibility that this bear market is likely to be longer than those we’ve experienced in recent years. The Fed is unlikely to “bail the market out” by cutting rates or providing liquidity to the markets as they continue their battle with inflation.
In past bear markets, we had falling inflation, and the Fed was cutting rates. What makes this environment different is that we currently have higher-than-average inflation coupled with rising interest rates and the likelihood that both may stay elevated for some time. These conditions create a great deal of uncertainty in the markets and the economy.
At Gulfside Wealth, we build diversified portfolios with high-quality investments that can weather a lengthy and significant market decline. This includes investments that can help to minimize the impact of inflation, like real estate and commodities, as well as investments with little or no correlation to equities, like market-neutral strategies. We also tactically increase our allocation to cash if warranted.
Our strategy for 2023 will be to maintain our focus on high-quality companies, stay diversified, and focus on dividends, which we believe will make up a larger portion of returns for some time. We will also look to average in at specific index and price levels. We believe markets will remain range-bound and potentially provide lower, but still healthy, returns than in recent years.
Discipline will be paramount, and we are committed to being responsible stewards of our clients’ hard-earned investments and guiding them toward and through the future.
While 2023 won’t be without its challenges, we are here to help you through them. As always, please call a member of our team if you have any questions or concerns.
- Bloomberg as of 11/30/2022
- Capital Group, MSCI, RIMES as of 11/30/2022
- Ycharts, as of 12/30/2022
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks, including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.
References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.
All data is provided as of December 30, 2022.
The Standard & Poor’s 500 Index (S&P500) is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Past performance does not guarantee future results.
Asset allocation does not ensure a profit or protect against a loss.
Due to the volatility of the markets mentioned, opinions are subject to change without notice. Any opinions or forecasts contained herein reflect the subjective judgments and assumptions of the author only and do not necessarily reflect the views of LPL Financial. Investing is subject to risks, including loss of principal invested. Past performance is not a guarantee of future results.
No strategy can assure a profit nor protect against loss. Please note that individual situations can vary. Past performance is no guarantee of future results.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
Please note that individual situations can vary, and therefore, this information should only be relied upon when coordinated with individual professional advice.)
For a list of descriptions of the indexes and economic terms referenced, please visit our website at lplresearch.com/definitions.