Market Review - Quarter 4, 2022
2022 was a brutal year for investors, with few places to hide. The war in Ukraine and central banks' fight against inflation led stocks and bonds sharply lower for the year. The fourth quarter bought some relief, but not enough to change the outcome for the year.
Source: FactSet
Equities around the globe struggled in 2022. Within equities, developed international markets in Europe, Japan, etc. (MSCI EAFE) outperformed the US equity markets in the fourth quarter and the year with a return of 17.4% and -14%, respectively. The outperformance came as the region had a larger exposure to commodity producers and defensive stocks, as well as lower exposure to technology companies. US equities (S&P 500) had their worst year since 2008 and fell 18.1%. Finally, emerging markets (MSCI EM) were the worst performer, with a return of -19.7% for the year led by China, which struggled as Covid lockdowns hurt its economy.
Surging oil prices in the first half drove massive gains in the energy sector. The energy sector gained 65.7% for the year, even though oil prices retreated significantly in the second half. In addition, defensive sectors such as utilities, consumer staples, and health care held up better amid the market carnage as investors sought safety. On the other hand, technology-related sectors were the worst performers, thanks to rising interest rates and recession fears.
Value stocks crushed growth stocks. Growth stocks, often synonymous with next-generation technology companies listed in the Nasdaq index, fell 32.5% as investors demanded certainty in near-term profits amid fear of rising interest rates taking a bite out of uncertain future earnings. On the other hand, value stocks, often considered undervalued, steady, and sometimes even boring dividend payers such as those listed in the Dow index, fared much better and only fell 6.9%.
Bonds had their worst year ever! The Federal Reserve raised the federal funds rate at the fastest pace in history with seven interest rate hikes, bringing the effective rate to a range of 4.25%-4.50% from zero in January. The speed of the interest rate hikes led bond yields significantly higher, driving bond prices to historic lows in 2022. The 2-year Treasury yield rose to 4.3%, up from 0.8% in January, while the ten-year yield rose to 3.8% from 1.5% at the start of the year. US bonds (Bloomberg US Aggregate) fell 13.1%, the worst year since the index's inception in 1976. Long-term bonds (Bloomberg US Treasury Long) with greater sensitivity to interest rates experienced the worst of the damage at -29.3%, while shorter-term bonds (Bloomberg US Treasury Short) offered the only bright spot for bond investors with a gain of 1.0%. Even Treasury Inflation-Protected Securities (TIPS), designed to protect investors in times of high inflation, did not offer refuge against rising interest rates, ending the year with double-digit losses. Finally, high-yield bonds also finished the year down 11.2%, primarily due to a flight to higher quality amid uncertainty.
Commodities gained as oil and natural gas hit highs, while gold was a disappointment. The war in Ukraine amplified inflation concerns sending food and energy prices higher for the year. Broad commodities (Bloomberg Commodity Index) gained 16.1% in 2022. Gold prices fell 0.7% as it struggled to compete with rising bond yields and a stronger dollar and failed to meet expectations as an inflation hedge. Higher interest rates in the US relative to global developed markets led the dollar to rally 9.5% for the year. Finally, US REITs lost 24.9% in 2022 over concerns of rising costs due to higher interest rates.
The classic "60/40" portfolio has only suffered losses larger than 2022's decline once in the last 45 years. With bonds suffering their worst year on record, the classic "60/40 diversified portfolio" comprised of 60% US stocks (S&P 500) and 40% US bonds (Bloomberg US Aggregate) suffered its second-worst year on record. It fell 16.1% going back to the inception of the Bloomberg Aggregate index in 1976. The 60/40's losses in 2022 were only topped by 2008's decline of 20.1%, which were driven entirely by losses in the S&P 500 alone.
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