December 2022 - Market Update

The Friedenthal Team

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Key Observations

Both equity and fixed income markets have performed quite poorly this past year, notably, at the same time. Investors typically rely on their allocation to bonds when equity markets come down, but unfortunately this strategy hasn’t been successful during this market cycle.

In the face of recession fears, the economy has stayed resilient with regard to low unemployment, high job openings, and significant easing of supply shortages & global shipping costs.

Despite lower inflation reports, the Fed has shown continued hawkishness, stating that the FOMC needs to see “substantially more evidence” before they can be confident that inflation is falling. This means, at least in the near term, higher interest rates for longer.

The Treasury yield curve has steepened slightly over the past month, although both the three-month and two-year yields remain significantly higher than the ten-year. Falling rate expectations have slightly lowered mortgage rates and corporate bond yields with overall financial conditions easing.

Unfortunately, all of the above has failed to deliver any lasting support to equity markets, with the S&P 500 restarting its negative trend from the past few weeks. This most likely reflects the growing concern over the health of the economy, which has overshadowed any rally resulting from the expectation of falling interest rates & inflation.

Data Dashboard

*Data Source: Bloomberg. As of 12/31/2022*

Stock Market

A very weak Santa Claus rally the last five days of December didn’t help to push the S&P positive in December with the index clocking a -5.77% monthly return. For the year, the stock market lost a total of -18.17%, the worst annual return since 2008. While stocks were down for the year, the S&P still ended above where it was at the end of 2020, meaning that it really just gave back part of the 2021 annual return.

The sector returns in 2022 were divergent. Energy was the only real winner in a sea of negative returns (Utilities was slightly positive), and Communication Services (Meta, Google, Verizon, Netflix) was the biggest loser. The Fed’s mission to slow rising prices in an economy fueled by excess money supply caused consumer-driven stocks to suffer.

Looking forward, stocks will continue to fluctuate based on the perceived likelihood of a deep recession. If the Fed is able to achieve the “soft landing” it hopes to accomplish, stocks will recover and look forward toward the next bull market. The more likely path is that there will be volatility as time passes and we interpret data, updating the probabilities and assumptions along the way.

December Monthly Returns (by US Sector)

Bond Market

Bonds had an (almost) unprecedented yearly loss. Interest rates increased rapidly over the last 12 months, and bond prices cratered as a result. Most bonds that are sensitive to broad interest rates or credit conditions were hit by this perfect storm, leaving investors looking at bonds for safety stunned in many cases at the loss in value. For many people, it was unheard-of that a US Treasury Bond could decline -16% in a year, but that is exactly what happened.

Not all bonds lost value this year. Floating-Rate Treasury Notes and other very short-term debt had positive returns. And of course, any bond that matured and paid back their principal was unaffected by the change in interest rates. In fact, having a bond mature this year allowed reinvestment at a higher rate, which over time will provide better returns.

Economics

The story of 2022 was primarily centered around rising global inflation, an extremely tight labor market, supply chain shortages, and ravaging war in Ukraine. Unfortunately, many of those topics will spill over into 2023. (Keep reading, there is good news next.)

There were a number of relevant economic reports to be shared before the Federal Reserve’s December meeting, a few notably positive ones. Both Headline Inflation (0.1% MoM) and Core Inflation (0.2% MoM) came in lower than expected along with negative core goods and softer core services indexes as well. Outside of retail sales and manufacturing production, strength in the economy has been surprisingly resilient. Unemployment remains low at 3.7%, jobs numbers grew even higher, and consumer confidence hit a high since April 2022. However, we are in an environment where good economic news can be interpreted as bad news…

The point where good economic news becomes bad for financial markets is when both investors and the federal reserve interpret positive data reports as an indicator that there is more work to be done by means of raising interest rates even higher. In their meeting on December 14th, the Federal Reserve raised the federal funds rate target range another 50 bps as expected, but the big surprise was when Fed officials actually increased their forecasts for core inflation and estimated peak rate. The Federal Reserve can only continue their hawkish interest rate regime as long as the economy doesn’t spill into a deeper recession. Market futures have priced in a lower interest rate peak and a pivot in policy sooner than the Federal Reserve forecasts. One thing is for sure, if inflation continues to fall and the general economy starts to weaken, we expect the Fed’s to change their tone.

Other notable global economic events:

China’s abrupt end to its zero-COVID policy dealt a heavy blow to its December activity.

President Zelensky visited the President Biden and reaffirmed the US’s support. Geopolitical risk continues to exist primarily centered around Russia and Ukraine ultimately causing tighter financial conditions and continued commodity supply shocks.

Tactical Updates

For Tactical Equity ETF portfolios, we traded out of Aerospace & Defense, Industrials, and Energy positions for exposure to precious metal commodities and Chinese Internet company equities. As for Tactical Equity Stocks, our sector concentration at the end of the month was primarily in Healthcare, Industrials, Materials.

As for Tactical Fixed Income portfolios, we stayed invested in the short-term floating rate ETFs and cut losses on the emerging markets, international, and short-term corporate bonds. We opted in favor of US aggregate bond markets, long-term corporate bonds, and short-term high yield corporate bonds.

General Client Considerations

IRS annual contribution limits for 401(k), 403(b), most 457 plans and Thrift Savings Plans (TSP) are increasing in 2023. Changing your elections at the start of the year can help you to spread out contributions evenly and ultimately maximize your tax advantaged retirement saving. In 2023, the contribution rate for these accounts is $22,500. This is an increase from the 2022 limit of $20,500.

Additionally, if you are 50 or older, the catchup contribution limit for 401(k), 403(b) and TSPs has increased from $6,500 to $7,500 in 2023. That means individuals who were born in 1973 or earlier can contribute up to $30,000 to these accounts. You do not have to wait until your 50th birthday to make catchup contributions - the contributions can start on January 1st of the year you turn 50.

With regard to IRAs and ROTH IRAs, the IRS changed the contribution limit from $6,000 to $6,500, and left the catch-up contribution at $1,000.

As we downshift from the holiday season, many of you likely have a list of To Do’s for 2023 including doctor’s appointments and organizational tasks. We suggest you add financial checkup to the list and encourage you to setup some time with us to review your financial plan. We look forward to hearing from you!

Thanks,

The Friedenthal Financial Team

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