Newsletter
Dear Client,
In 2022, global capital markets had to contend with an array of geopolitical and economic headwinds resulting in extraordinary turbulence. U.S. equity benchmarks had their worst annual performance since 2008, with the S&P 500 declining over 18%, and the tech-heavy NASDAQ falling over 32%. Bond markets were not spared with the Barclays Bond Aggregate Index declining over 13%, marking its worst annual performance since the index’s launch in 1976.
While the turmoil can be attributed to a myriad of reasons, the predominant driving factors were inflation and interest rates. Inflation measures reached 40-year highs as a result of unprecedented stimulative fiscal and monetary policies, supply chain disruptions, skyrocketing energy prices, robust employment and wage gains, the Russia-Ukraine war, and China’s zero-covid policies. As a result, the Federal Reserve responded to stubbornly high price pressures with the fastest interest rate hiking cycle since 1981. The Fed hiked the overnight Federal Funds Rate by 4.25% across the final seven meetings in 2022, while at the beginning of the year, markets were only pricing in 0.75% in rate hikes. The Fed’s hawkish pivot from a “transitory” inflation outlook had the most significant impact on rates and spreads. The 2-Year U.S. Treasury yield, which is most sensitive to the Fed’s monetary policy, rose over 4% to a high of 4.80% while the longer 10-Year U.S. Treasury yield rose as much as 2.84% to a high of 4.34%. The dramatic rise in the long end of the yield curve broke a 40-year downtrend in rates. Yet even that was not enough to keep the curve from inverting in April, and it reached a low of -0.84% in early December, its deepest inversion since 1981.
The U.S. Dollar Index (DXY) was up by 20% at its high in September thanks in large part to the Fed’s aggressive rate hikes, investors seeking a safe-haven and hedging. The dollar gains would have been a record had those levels held into year-end, however, other central banks became increasingly hawkish with the Bank of Japan notably doubling its upper limit on its 10-year yield target. Commodities were exceptionally volatile primarily due to the conflict in Ukraine. The Bloomberg Commodity Index (BCOM) was up almost 42% at its high in March with WTI crude oil also peaking at this time after a gain of over 73% before retracing and finishing the year with gains of 13.75% and 6.71% respectively.
The Fed now must determine how far it ultimately needs to raise the policy rate and how long it will have to leave it there. Chair Powell has reiterated on numerous occasions that they do not want to repeat past mistakes of lowering rates too soon, and that it needs to be a prolonged process. As we turn the page to 2023, the lagging effects from high prices and rising rates will likely trigger a slowdown in global growth triggered by an investment downturn as inventories are pared down and consumption is downshifted. The benefit of slackening growth is a slower pace of price gains and a recession is not a forgone conclusion. Resilient consumption should help put a floor under demand; and a combination of a deep European recession, China turmoil, and a warm winter in the U.S. could temper inflation enough to provide the Fed the leeway to end rate hikes earlier than expected and even prompt cuts in the latter half of 2023. Regardless of recession or not, the expected moderation of growth and disinflation it will bring should weigh on corporate revenues and earnings growth. This will likely lead to further equity market volatility through the first half of 2023. Past cycles have shown that the stock market has started to anticipate economic recovery in advance of the end of any slowdown or recessionary period, so we are optimistic there will be sound tactical investments for our portfolios in the year ahead.
We thank you for your continued support, and wish you all a happy and healthy new year.
Regards,
Edge Wealth Management
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