I wrote the above paragraph in my 2022 outlook….
After three consecutive years of robust equity returns, 2022 brought an unexpected disruption to this trend, leading to a sudden reversal in all the previously mentioned positive factors. From a return perspective, 2022 marked the third-worst calendar year for a 60/40 portfolio.
A significant portion of this distress resulted from widespread inflation, a phenomenon not witnessed to this extent since the late 1970s, coupled with the Federal Reserve pushing short-term interest rates to nearly 5%. The rapid rise in interest rates posed challenges for both bonds and equities. As 2022 ended, investor pessimism reached unprecedented levels.
As 2023 trudged on, mega tech companies held markets up, while the rest of equities and bonds continued to underperform. This cycle continued until the 4th quarter of 2023, when we finally saw interest rates recede and the pain soften.
It took almost 2 years, but finally there was something to get excited about in markets. In just a couple of months times, the 10-year treasury fell from 5% to under 4%. As a result, bonds, small cap stocks, value stocks, and all other interest rate sensitive assets rallied into the end of the year.
2023 ended on a high, by recovering much of the damage felt in 2022. The S&P 500 ended up 24%, the Nasdaq + 37%, Small Cap Stocks +16%, and even the US aggregate bond index ended a two-year losing streak by gaining 5.6%.
What Caused Rates to Fall?
The simplest way of telling the story is to go back and look at how quickly inflation ran out of control and the veracity to which the Fed responded. To curb 9.5% inflation, which was the highest reading we’ve seen in nearly four decades, the Fed tightened short-term interest rates at the quickest pace on record.
When this occurred, inflation started to dissipate, but not as quickly as the Fed would have liked, so they stuck to their mandate. Unfortunately, from an economic perspective, there is a lag in the data. No one ever knows if the Fed went too far or not far enough until it’s all set and done.
Again, we don’t know for certain, but with the recent decrease in long-term rates and increase in equity and bond values, the market believes that the Fed did their job and will begin to ease policy going forward.
Additionally, there are banking standards which will sunset in March, which should take more liquidity out the economy and force the Fed’s hand even further.
The other possibility is that we are headed towards a recession.
The 10-year treasury level is a great indicator for future growth and potential recession. With the 10-year falling from 5 to 4% in two short months, it could be telling us that the economy is feeling the pain and recession may be unavoidable. Only time will tell.
Positioning
Headed into 2022, we were overweight equity and intermediate-term bonds. We remained unchanged throughout 2023 and portfolios responded nicely. As we move into 2024, we will look to start to pair back these exposures to a more neutral weighting.
As always, please don’t hesitate to reach out with questions. I hope everyone has a great start to their year.
Thanks
Frank Vance
Retirement Capital Advisors
800 Battery Ave SE
The Battery, Suite 100
Atlanta, GA 30339
Office- 412-722-3795
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