The average return for the US stock market since 1926 is 10%. The bond market has returned 5% per year over the same time. Those are great statistics, which are also kinda meaningless to us as investors.
Can you name one person who’s been invested since 1926? Neither can we.
During the past almost 100 years there have been periods of extraordinary gains and periods of market struggle. Wealth planning and investing would be so, so, so much easier if the returns were consistent, but this is not how the world works.
What matters more is the returns we actually get, not the historical average of the last 96 years!
Now that we have established that stock market returns aren’t steady, it goes without saying bad years happen. After 2022, everyone now knows bad years can happen in the bond market as well.
Moral of the story: Stuff happens … much of it (apparently) over the past 12 months.
As we enter 2023 we know that there are a lot of you who are nervous/apprehensive/concerned/(insert your favorite adjective here) about your financial assets. We are here to tell you three things:
- This feeling you have is perfectly normal and expected. If you feel all rose petals and unicorns about 2022 you are either the best short seller east of the Mississippi or an amazing stock picker who should be running money for the PA State pension plan.
- It is important to not forget that 2019 through 2021 were really, really good for investors. Stock markets were up, the bond market provided gains as rates moved lower, and real estate values burst to levels no one expected. And all of this happened despite the world shutting down in March 2020 for Covid.
- The future for financial assets is bright. What happened in 2022 isn’t so unusual. It was more of a normalization – a revision to the mean – then market crash. It never feels good when it happens, but markets “reset” from time to time as a normal part of the process.
Right now, it is important for you, the investor, to understand the world we are in so as to not make any life-changing decisions with your money based on emotions. We believe that an educated investor – an investor who understands the investment landscape as well as their own investment time horizon – makes the wisest decisions.
Over the course of the next few minutes, we will do the following:
- Review what happened in 2022 and why. Hard to comprehend the future if you don’t understand the past.
- Give you our themes for 2023 and beyond so you have an understanding of where the world is and why we are here.
- Help you utilize this information to make smart, rational decisions with your investment dollars.
Like we said up front, 2022 was not a feel-good kind of year for investors. No matter your risk tolerance, 2022 was not a good one.
The S&P 500 was down 18% for the year while the Aggregate Bond Index was off 12.5%. The technology-heavy NASDAQ index was down more than 30% when the ball dropped in Times Square. Major global stock markets were negative as well.
What made 2022 more of a unique investment experience, and an outlier, was the poor performance of the bond index in parallel with a negative stock market. In a year when aggressive assets took it on the chin, the more conservative investments didn’t act as the buffer they have in past investment cycles.
For the investor with a 60/40 asset allocation of stocks/bonds, 2022 was the worst performance year since 1968. To give you a reference point for how long ago that was, it was before the NY Jets last won a Super Bowl (1969).
Why did this happen? The unique situation of the post-Covid world. 2022 was the year that all of the economic anomalies caused havoc. And by havoc, we mean inflation.
After many months of proclaiming that inflation was “transitory,” the Federal Reserve (The Fed) began an aggressive rate hiking cycle that we expect to continue into 2023. As bond yields boomed, bond prices dropped like a lead balloon.
By the end of 2022 the 2-Year Treasury Bond was yielding 4.41%, up from 0.75% at the start of the year.
If only Julie Chen from the TV reality show Big Brother was there to tell us to “expect the unexpected.”
4 Themes for 2023
Some years turn out to be smooth riding as others feel like a constant headache. Everything can look so easy to predict on January 1. Then the unexpected happens:
- A war breaks out in Europe.
- Central banks move to increase interest rates more aggressively than even they believed possible.
- Asset prices start to fall … before making you believe recovery is here, before falling again.
- EVERYONE starts to predict the next economic recession is right around the corner.
If any of that feels familiar, it should. No one predicted it, yet we just lived through it.
This is why our themes this year have more to do with maneuvering through an unsure immediate future with a bright eye toward the future.
The end is not near. No sir! Just the opposite.
Theme #1: A Balancing Act for The Economy and the Fed
Our first theme is the most important for markets in 2023. We believe that the current economic situation is not so simple or straightforward. Lots of ifs, not a lot of clarity.
Leadership at the Federal Reserve Bank (The Fed) has the job of looking at all the economic data, reading those tea leaves, and making monetary policy designed to keep both inflation and unemployment low. No easy task in more “normal” times, let alone a few years after a global pandemic.
Keep interest rates too low and inflation becomes a problem. Raise rates too aggressively and unemployment gets to untenable levels while killing the economy.
As we now know, interest rates were held down at very low levels for an extraordinarily long period of time – at first to deal with the 2008 financial crisis, later on to manage through the Covid economic shutdown. The result was an inflation spike similar to but different from the great inflation of 1965-1982.
The reaction from the Fed in 2022, much like the 1970s, was to aggressively increase interest rates.
The phrase “this time is different” is about the worst thing you can say when it comes to financial markets. Nothing is really new at this point. It is never different but more of a variation on a theme.
The pandemic has certainly created an economic variation. The world stopped, then slowly opened up again. That sudden, unexpected situation and the reaction from governments, corporations and consumers drastically altered the way the world functioned pre-shutdown. The result of it all was:
- We are in a period of heightened inflation, not due to a wage spiral like we saw in the 1970s, but by supply shocks and sectoral demand shifts, not by excess aggregate demand.
- The job market still looks very hot and, in our opinion, is likely to stay that way. Wages are rising too fast to be consistent with acceptably low inflation.
The sticky inflation creates considerable uncertainty about where interest rates will peak in this Fed tightening cycle. Expectations are for small rate increases at the upcoming February and March Fed meetings, but is that it? Do rates hold at these levels or does the Fed start to reduce rates later in 2023?
In our opinion, a quick flip from rate increases to easing in 2023 appears unlikely. But who knows? Last year at this time nobody we are aware of was predicting what happened in 2022.
The investor waiting for a clear sign that Fed policymakers are ready to cut rates could be left standing on the sidelines longer than they currently expect. Or be absolutely correct … and that’s the problem.
At the start of 2023 the economic landscape is still not “normal.” This makes it much harder for the Fed to effectively use interest rate policy to shape the world. The direction of policy and the effect it will have on the economy are very much not a given.
This leads us into Theme #2 …
Theme #2: Time to get a grip that inflation will continue to be a thing
This is an important concept for you to get an understanding of as it is so important to the financial decisions you make in the years to come.
We aren’t talking about 1970s-style inflation that wrecked the economy and led to Fed Chairman Paul Volker implementing rate increases that caused a massive economic recession. No. What we are talking about is a more 1980s-like environment where inflation was present but moderate.
We say this for a number of reasons. The world has changed. There are now structural factors which are likely to tilt the U.S. and other major developed economies toward higher inflation. These include:
- Slow or negative population growth in many developed countries, aggravated by lower workforce participation rates.
- A “reshoring” of global supply chains, which could make production less efficient.
- Demand pressure from heavy capital spending on both traditional energy sources as well as the transition to sustainable energy sources.
- A greater appetite for deficit-financed spending on the part of many developed market governments.
This is not necessarily a bad thing. The 1980s aren’t looked back on as terrible times like the 1970s.
Theme #3: Asset Allocation and the Return of Yield
Out of bad usually comes some good. For you, the good news from 2022 is the reset that happened for both the stock market and the bond market. For literally the last decade, we have been talking about “interest rate normalization,” which is just a jargonish way of saying interest rates will move higher.
This happened in 2022. Cash and bond investments again make sense to have in your portfolio.
For stocks, the reset was about valuations. Corporate earnings were roughly the same in 2022 as 2021. In certain segments of the market of stocks the “correction” or revaluation downward will likely continue.
We know that asset allocation provides you with the vast majority of your expected gains over time. When interest rates were at much lower levels, decisions had to be made about increasing stock market exposure for many investors. To make the math add up for the returns needed by investors to have a successful outcome, many made the decision to increase stock market exposure.
For those in retirement (distribution phase), the decision to increase equity exposure happened sometimes out of greed, but mostly out of a desire to not alter lifestyle choices. It was really hard to get the necessary returns of a traditional 60/40 allocation when the 40% in bonds was paying income of 2.5%!
Of course, the decision to increase equity exposure came with a much larger chance of losses. The return of yield now allows you to have a more traditional mix of assets with a lower standard deviation (read: less variability of returns).
For those in the accumulation phase, assuming you are properly saving for your future, we do not advocate changing what you are doing. Keep making your contributions to your 401k and ROTH IRAs. Increase your savings rate when you can. Given your long timeframe, the amount you invest is more relevant to your success than what the stock market does in any given year.
If you are getting close to retirement (preparation phase), now is the perfect time to evaluate where you are at. The shift in markets gives you the perfect opportunity to make the necessary changes to set yourself up for long-term financial success.
Theme #4: Focus on the next decade, not the next Quarter
This is about both your personal investments and about the world.
On the personal level, one of the biggest financial mistakes you can make with your investments and investment plan is being overly concerned with what’s happening right now with no big picture perspective. Bad decisions are often the result. Decisions that are costly, not just today, but over time.
Now some of you might be saying to yourself, I’m close to retirement (or in retirement) so I don’t have to think about what’s happening 10 years from now, that’s for these Millennials and Gen Zers.
Nope. Not at all true.
(Big Caveat: There are issues that necessitate change. Winning the lottery or the sudden death of a spouse are two extreme examples. There are good and bad things that do require a radical change of direction. What we are talking about is everything else).
What is happening in the news, or the business news, today are not things that should significantly change your investment plan. What happens today, tomorrow, next week, next year are not the things we should be focused on. Long-term underperformance comes from emotional decisions.
In our experience, emotional decisions are a result of two things – not understanding your investment timeframe and/or not having an adequate savings plan to begin with. Emotional decisions tend to come in two flavors:
Aggressive: In 2019 it seemed like everyone had a big tolerance for risk. Why? The S&P 500 was up more than 30%. Clients would question the need for bonds. Sometimes they would question performance as it wasn’t “keeping up” with “the market.”
Overly Conservative: In 2022 the story was different. The S&P 500 lost value all year, ending the year down about 18%. All of a sudden there were clients who wanted “out of the market.” Conversations were again focused on risk tolerance … which suddenly wasn’t as high as it was the year prior.
Funny how that works.
Moving on to the world we live in, you can ALWAYS find a reason to be pessimistic about the future. Do you remember the book “The Great Depression of 1991?” We do. We also remember the follow up titled “The Great Depression of 1992.” We do remember an economic recession around that time, but no depression.
Sounding the alarm about all the bad in the world, in a way, can be appealing.
Yet, when you dig beyond the alarmist thought process, there is reason to be very, very positive about the future. Two examples:
- Fear of the End of American Prosperity: It has been long predicted that rival nations and political systems would overtake what we have going here in the United States. It happened around the time of World War 2, before the new international order put the United States at the dominant center of the global economy. In the 1980s Japan was the concern. Rockefeller Square and Pebble Beach Golf Club were purchased by Japanese entities at peak prices. More recently, China has been the major rival that would ruin the American way of life. At the end of the day the stability, open markets and rules-based institutions of the current world order are good for peace, trade and economic growth, and investors.
- Young people feel like they have no future due to climate change: It’s a problem, but not one in which humanity is doomed. Problems lead to opportunity. The opportunity is what leads to innovation, and those innovations are coming to fruition today. The transition from gas powered to electric vehicles is a real thing. Renewable energy development has a long runway with tens of trillions of investments that will happen in the coming years.
When we look back at the world of 2023 in 2033, we think you will be amazed at the changes that have taken place. Just like the changes that happened between 1983, 1993, 2003 and 2013 were substantial. Just like in the past, today’s challenges are what lead to tomorrow’s innovations.
There are also ALWAYS reasons to be positive about the future.
Putting It All Together
After three very good years for investors 2022 gave us all a big dose of reality. Not only did the stock market enter a bear market, but the bond market did as well. While bear markets are never fun, last year felt particularly bad for many.
While it is easy to expect 2023 to be just as bad, we see an investment landscape that is ripe with opportunity. The poor markets of 2022 brought stock market valuations back to realistic levels. The bond market now provides reasonable income without taking on more credit risk than most of us would be comfortable with.
We are in a period of secular change. Globalization is changing to a more regionalized approach to trade. Moderate inflation looks to be with us for the long term, but not in a harmful way. Climate change is being addressed with movement toward renewable energy sources and electric vehicles.
The opportunity is there for you if you are willing to have perspective. Times of change are never easy.
The reason we don’t give predictions on what the stock market will do this year is because it is a guessing game. What we will say is that over the course of time – the next 5-10 years – you can expect to see big changes that will have positive implications for stocks.
Now more than ever, sticking to a proper allocation of your investments and having a longer-term perspective are the key to successfully reaching your investment goals. This goes for the 22-year-old who is just starting to save along with the 85-year-old couple who are living the good life in retirement.
On behalf of Magellan Financial we would like to thank you for taking the time out of your busy day to take in our thoughts and opinions. If you found this helpful, please forward it on to others. If you have any questions on the materials presented, would like to be added to our email list, or would like our help with your investments, we can be contacted at 610-437-5650 or via email.
Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
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