December 2022
On the very first business day of 2022 the S&P 500 index hit its all time high of 4,797. For the next nine months it was downhill. The index was in bear market territory by June and bottomed out in October at -25%. In describing the behavior of the 2022 financial markets, one word that has been used is "extraordinary.” In March the federal funds rate was 0% and the Federal Reserve was still practicing quantitative easing (QE), the practice since 2008 of buying large amounts of bonds to make borrowing cheaper. By the end of the year, the funds rate had been raised to 4.5% and QE was no more.
Concerning the United Kingdom’s Royal Air Force, Winston Churchill famously declared: “Never was so much owed by so many to so few”. In 2022, investors can declare about the Federal Reserve Board members: “Never has so much blame been owed to so few.” Certainly, it was obvious after Covid, that a return to economic ‘normalcy’ was not going to be easy. Massive government outlays and low interest rates flooded the market with free money. It was inevitable that inflation would follow. The Federal Reserve should have been ready to act, but it failed to take the required initial steps. Instead even into March it described price increases as transitory, that is, brief and ok to ignore. Throughout the rest of 2022 the markets became fixated on the Reserve, over reacting to its latest action, no-action, the minutes of its meetings and public comments by Chairman Powell and other Board members. The markets sold off on good economic news, because it meant the Reserve would probably respond by raising interest rates. Bad news was seen as good news. In August the typical market inclination toward optimism got the best of it. Rumors spread that the Reserve was going to soon stop raising rates for fear of causing a recession. By September that proved not to be the case and the S&P moved back into a bear market, staying there for the rest of the year. The Reserve did what it had to do, but had waited too long. Because of the delay it had to take more steps more quickly than markets could absorb.
You didn’t hear much about it, but the fourth quarter was good for investors, especially compared to the first three. Although expectations for higher rates, slower economic growth and low profits continued to plague the bigger tech companies, less economically sensitive companies and those trading at lower valuations outperformed as there was a shift towards defensive sectors. International markets outperformed the US as China finally abandoned its Zero Covid policy and the UK reversed the spending and tax plan put forward by Prime Minister Liz Truss whose term in office lasted only seven weeks, a record.
Also under the radar, bonds finally showed life as investors reacted to US economic resilience. Both high yield and investment grade bonds posted positive returns as investors reacted to lower monthly increases in the Consumer Price Index, which has steadily fallen from 9.1% in June.