In a Nutshell: Stocks closed out the year down around 20%, the worst since the Great Financial Crisis. The bond market finished down 14%, making 2022 the first time in the last 95 years both stocks and bonds were down double digits in the same year, capping a very difficult year for investors.
Domestic Equity: Still a Bear
The S&P 500 closed the year down around 19% while the Nasdaq index, sporting the likes of Tesla, Apple, and Microsoft, was down over 33%. The entire calendar year of 2022 was a down-trending bear market. We saw valiant attempts to break out of this channel to close out the year, but ultimately the trend was too strong. As we outlined last month, we came into December at a make or break point for stocks. We saw sentiment and price extended while attempting to break out of the down-trend. As anticipated, stocks were rejected in an attempt to break out. The same key question from last month remains: How do stocks respond to failing to break out on the first attempt? Do we fall to lower lows within the down channel, or do we have another attempt at breaking out around the 4000 level on the S&P 500?
Again, reviewing our broad market strength indicator, we see that this indicator continues to reside in negative territory, confirming our bear market in stocks.
Our stock sentiment indicator is fairly neutral at the moment with stocks trading toward the center of the down sloping channel. In 2022, every trip to the red line (positive sentiment) resulted in a move back to the green line (negative) and more importantly, new lows in the stock market. We’ll continue to monitor this relationship in 2023.
The Federal Reserve raised interest rates another 0.5% in December of last year. Fed chair Powell outlined the Fed’s resolute stance in defeating inflation and reiterated they anticipate rates will have to stay higher for longer than most market participants are expecting. The vast majority of Fed participants saw rates going above 5% in 2023 before pausing (and not cutting) interest rates. That forecast indicates rates will have to go up at least one more time in 2023, with the next opportunity in early February. The Fed has maintained its stance in tightening financial conditions in the face of a recession in order to fight inflation. Until that stance changes, risk assets will likely struggle.
Global Equity: Relatively, Stronger
Global equities have broadly under performed U.S. stocks for the last two years and for the vast majority of the last five years. However, over the last quarter of 2022, global stocks have been stronger. The forward looking data in 2023 still looks challenging for the global economy, but now that China has ended their zero-Covid policy, perhaps they are the engine that restarts the global economy. However, on the chart below you can see we have one more hurdle for global equities to get over first. We’ll continue to closely monitor the data and trends as they develop in this sector.
Real Estate: Weaker than Stocks
Real Estate limped across the finish line in 2022, finishing down 27% on the year. That return trailed most major stock indices aside from the tech-heavy Nasdaq. Often when investments see significant declines, it’s worth examining whether buying opportunities have formed. This is where the context in the real estate sector matters. Unfortunately, interest rates and borrowing costs are still much higher than we’ve seen in the past decade. However, residential and commercial real estate haven’t seen much of a price decline since the peak in early 2022. Additionally, the difference between the 10-year U.S. treasury and a 30-year mortgage is at the housing crisis levels from 2008, indicating a lack of willingness in lenders to issue new debt to prospective buyers. Putting all these factors together, and it seems something has to give, and real estate prices will have to fall further. We’ll continue to avoid this sector for the foreseeable future.
Commodities: The Waiting Game Continues
Commodities finished up 16% for the year, but down about 18% since June. While it was a good year for the sector, the last six months was easily the worst stretch since March of 2020. More specifically, commodities have been trending lower for months and have traded in a narrow 10% range since July, which is pretty tough to do for such a volatile asset class. The picture below shows the trend has broken and the bottom of the box has been tested three times. Another test of that lower level seems unlikely to hold.
Gold continues to show signs of strength into the close of 2022 after trading in a downtrend for most of the year. With real interest rates starting to stabilize, gold has been given the green light to head higher. The two biggest factors for gold will be inflation and interest rates. If both fall, the global economy will likely struggle, but gold should perform well for investors.
Fixed Income: Decision Time for Rates
Generally speaking, interest rates finished the year at least twice as high as they started the year, although they remained well off the high water mark for the year. You can see this below as it appears we had a slight break in trend to close the year, but still hold the 3.5% level on the 10-year U.S. treasury yield – an important level going forward. Once again, we find ourselves in a precarious position in the bond market; the Federal reserve is projecting higher interest rates in early 2023 then a pause, but longer-term bond yields haven’t responded as if they believe that path will happen.
You can see this same pattern on the 30-year U.S. bond yield as well below. Holding a big support level at 3.5%, but far from old highs.
The Fed and the bond market seem to be at odds for the moment. The Fed sees rates higher, the bond market doesn’t. The Fed doesn’t think inflation is contained, the bond market indicates it is. The Fed has said they won’t be cutting rates any time soon. The bond market thinks cuts are coming in 2023. Time will tell as to who is “right.” Interest rates and, by extension, the bond market, will be the key for investment markets for 2023. The path of interest rates will likely be the primary driver for all of the other asset classes we follow.
All Terrain Portfolio Update
We continue to hold small positions in defensive stocks as well as the U.S. dollar. The vast majority of the model remains in risk averse, short-term treasuries and notes that are paying interest in the 4% to 5.5% range. Our positions will be largely the same to start 2023 as they were at the end of 2022, aside from new precious metal positions. Our data and outlook continue to be weak for the first half of 2023, so we will remain risk averse and agile until the data improves. We will continue to wait for investment opportunities, and in the meantime, follow our indicators and process to adjust risk as new data is presented.
Past performance is not indicative of future results. Other asset classes or investment vehicles may be used in client portfolios and client portfolios may not hold all positions of the model at the same time as the model. This chart and its representations are only for use in correlation to the proprietary timing model by Arkenstone Financial, Registered Investment Advisor. Actual client and All Terrain Portfolio(TM) positions may differ from this representation.
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