2022 Year-End Market Update

Nick Levinson Comments, Life with Money

Happy new year! While the past year had some good news (see Economist article, “What 2022 Meant for the World”), we hope 2023 brings some relief for the financial markets.

As you probably already know, 2022 ended with stocks and bonds down significantly, despite gains in the fourth quarter.

The US, developed, and developing international stock markets all declined between 15% and 19% for the year, with the US off the most of the three broad stock categories (figures are for Vanguard’s Total US Stock Market index fund, Developed Markets index fund, and Emerging Markets index fund). The declines were tempered by fourth quarter increases of 7-8% for the US and developing international, while developed international rose a stunning 17% for the quarter. These declines followed three years of strong returns for global stock markets, with the US rising 31% in 2019, 21% in 2020, and 25% in 2021.

Bond prices declined even more than stocks relative to their typical performance, with high credit bonds down 13% and high-yield bonds down 9% for the year (figures are for Vanguard’s Total US Bond index fund and High-Yield Corporate Bond fund).

As Wall Street Journal columnist Jason Zweig put it in mid-2022:

“For most of the four decades since 1981, interest rates have been falling and bond prices rising, creating a tailwind of capital gains for fixed-income investors. You not only earned interest on your bonds but pocketed extra profit as they went up in value.

“Over some long periods, such as the 20 years ending in March 2020, bonds earned even higher returns than stocks, without any of their bloodcurdling losses.

“Those glory years are gone …

“According to Edward McQuarrie, an emeritus professor of business at Santa Clara University who studies asset returns over the centuries, … the broad bond market has performed worse so far in 2022 than in any complete year since 1792 except one. That was all the way back in 1842, when a deep depression approached rock-bottom.”

But here too, the declines leveled off in the fourth quarter, when high credit bonds rose almost 2% and high-yield close to 5%. The full-year declines similarly followed strong returns for the bond markets in 2019 and 2020, with US high credit rising 9% and 8%, respectively. (Bond prices declined almost 2% in 2021 as inflation started to rise.)

The stock and bond price declines stem largely from global interest rate increases in 2022, designed to tamp down persistent inflation around the world. The US Federal Reserve raised the short-term rate it controls from 0% at the start of the year to almost 4.5% at the end. These interest rate increases have started to moderate inflation, which peaked above 9% in June and declined to 7% in December. The inflation reductions, and the Fed’s lower rate increase in December (0.5%) than earlier in the year (four 0.75% rate hikes), appear to have played a significant role in the stock and bond market gains in the fourth quarter, which have continued into the beginning of 2023.

The big questions for the markets going forward are whether inflation will remain high, and if so, how aggressively central banks around the world will continue to raise rates in response. Large rate increases could lead to global recession and further stock and bond price declines. Smaller increases could produce a “soft landing” that would raise market prices with a minor recession or none at all. Other important factors include a possible resurgence of Covid, ongoing war in Ukraine, international tensions with China, and economic policy gridlock in the US.

Despite the declines and on-going uncertainty, PPA continues to advise sticking with asset allocations appropriate for your specific situation. As Zweig noted about 2022 in a more recent column:

“Risk-return relationships aren’t always normal, though—and that’s exactly the point.

“Stocks normally go up—but not always. Bonds normally are safer—but not always. Nothing in financial markets is constant or permanent.

“We could already be in a radical new era of rising interest rates and raging inflation. The more sensible assumption, though, is that a once-in-a-blue-moon bad year for bonds doesn’t invalidate decades of data showing that, on average, they can effectively diversify the risks of stocks.”

New York Times columnist Jeff Sommer made a similar point in his Dec. 16, 2022, column:

“Because the stock market tends to rise over long periods, and because bonds are now generating reasonable income (as I explained last week), it’s wise to invest for a long-term horizon in low-cost index funds that track the entire stock and bond markets.

“Don’t base your investments on specific predictions of where the stock market is heading over the short term, because nobody knows. Making bets on the basis of these forecasts is gambling, not investing.”

We will continue to monitor economic conditions and consult with you about your specific situation and investment opportunities. As always, please feel free to check in with your PPA advisor with questions and comments.