January 17, 2023 by Ethan Gilbert
The 4th quarter was a much-needed reprieve from the poor performance of markets in the first 9 months of the year. Events like the midterm elections and the FTX/crypto blowup caught headlines along the way, but the driver of market performance continued to be inflation and the Federal Reserve.
We finally received good inflation numbers with the Consumer Price Index reporting below expectations in two of the three months. The Federal Reserve’s preferred inflation figure, Core PCE, also came in at or below expectations for the quarter. Despite the good data, the Fed maintained a hawkish tone causing selloffs in stocks and bonds whenever Jerome Powell got in front of a microphone. Net-net the data won out giving stocks and bonds a boost as we closed out 2022.
The “good news is bad news” phenomenon was on display – strong manufacturing and employment numbers led to market selloffs. Stocks seem to be pricing in an overreaction from the Federal Reserve as Jerome Powell continues his quest to quell inflation.
US stocks had an outstanding October (+8%), followed by a strong November (+5%), and then a weak December (-6%) to finish the quarter up 7%. With the exception of long-dated government bonds, cryptocurrencies, and home prices, all asset classes posted positive results in the fourth quarter.
The following bullet points were some of the highlights from the quarter:
International Stocks led all asset classes, gaining 18% in the quarter, aided by a weakening dollar that declined 7.7% relative to a basket of international currencies.
Value stocks continued to outperform growth stocks. In the 4th quarter, we saw a 10% outperformance. For the year, it’s 25%.
The Federal Reserve again hiked interest rates at both meetings, the first by 0.75% and the second by 0.50%. That brought the Fed Funds Rate to 4.375%.
Despite the Fed’s hikes, interest rates were little changed with the 2-year and 30-year rates increasing by 0.2% while 3-year and 5-year rates slightly declined.
Gold finally caught a bid, finishing the quarter up 9%. Despite the strong performance, the precious metal only finished the year up 1%, falling far short of its billing as a great hedge against inflation.
Housing prices have pulled back, falling 3% from their all-time highs over the summer.
People who own cryptocurrencies continued to have a rough go of it with Bitcoin dropping another 15% in the quarter to finish the year down 64%. The fourth-largest crypto exchange, FTX, was revealed to be a fraudulent company, and the largest publicly traded crypto exchange, Coinbase, fell 45% in the fourth quarter to finish the year down 86%.
On the year, technology stocks got killed with Google (-39%), Amazon (-50%), Facebook (-64%), and Tesla (-65%) losing huge amounts of market cap. Meanwhile, drug makers (Eli Lilly +34%), Defense companies (Lockheed Martin +40%), and Energy companies (Exxon Mobil +87%) had banner years.
A big storyline for next year will be whether the economy can avoid a recession, and how well corporate earnings hold up. The earnings of the S&P 500 are forecast to have declined 3.9% in 2022. Analysts are expecting a 10% jump next year. The market seems to have priced in a smaller increase or at least high uncertainty around those earnings. If companies can deliver what analysts are forecasting, expect to see a strong rally in stocks. Historically, corporations have averaged real earnings growth of 2.1%.
The Federal Reserve has signaled they expect to hike interest rates 3 times in 2023, getting the Fed Funds rate to 5.1% next December. The market isn’t buying it, forecasting two 25 basis point hikes early in the year followed by a 0.25% cut at the end of 2023. These actions will impact the market but don’t expect the Fed to be as big a player in 2023 as they were in 2022. Another thing to remember is the Fed is selling $95 billion in assets each month. As long as that continues, that process will be a weight on all asset classes.
With a divided Congress, expect little to happen legislatively in the next two years. However, international affairs could drive markets this coming year. The continued war in Ukraine presents an opportunity for market movement both positively and negatively. Another concern is China’s recent “election” which saw a consolidation of power under Xi Jinping, and the new Standing Committee has no pro-market advocates. How China handles Covid going forward and any aggression towards Taiwan will be market-moving.