I think it’s safe to say that most of us are happy to close the books on 2022 and move on to 2023. After three straight years of impressive stock and bond returns, prices reset across asset classes to reflect a new investing environment. Financial asset prices have historically increased approximately 70% of calendar years since the early 1900s, but the bill came due in 2022. Rising inflation, caused by both supply and demand tailwinds, forced global central banks to rapidly raise interest rates. The U.S. central bank, the Federal Reserve, raised their key rate from 0% to 4.25%. Meanwhile, fiscal authorities also slammed their foot on the brake, cutting approximately $1 trillion in spending as pandemic-era stimulus measures expired. The effect on financial markets was severe, both stock and bond markets suffered historical losses, with the S&P 500 posting a return of -18.1% and the closely followed Barclay’s AGG bond index down 13%.
Despite policymakers’ efforts to curtail economic demand, labor market and consumer fundamentals were resilient throughout 2022. The U.S. economy added an average of 391,000 jobs per month during 2022, and the unemployment rate matched its pre-pandemic 50-year low of 3.5% in September. Consumers battled through inflation, spending an inflation-adjusted 3.6% more in 2022, nearly double the 30-year average. Unfortunately, policymakers are unhappy with the strength of the consumer, and we expect they will continue to raise interest rates to put additional downward pressure on demand and economic fundamentals. The effects of their policy are beginning to surface: higher financing rates have led to lower demand in the auto and housing sectors, retail and wholesale inventories are at their highest post-pandemic levels, and several leading economic indicators have trended lower over the past several months. Going in to 2023, we expect additional weakening in economic conditions. Through the end of 2022, the Fed signaled the need for additional rate increases, which will continue to put pressure on economic conditions. Thankfully, this will help ease inflationary pressures, which is ultimately necessary for the Fed to end its monetary tightening cycle.
Suffice it to say, storm clouds remain on the horizon, but there is good news: The Fed’s actions have removed financial froth from markets. Prior to the Fed’s hiking cycle, stocks were trading at their most expensive valuation since the technology bubble in 2000, and bonds were paying historically low yields. Now, stocks are trading at levels consistent with long term averages and bonds are offering the highest yields in over a decade. It is impossible to predict short-term fluctuations in markets, but patient, disciplined investors should feel comforted in the opportunity to build positions at prices that offer greater bang for your buck than has been available over the past cycle. Additionally, just as financial assets sold off well in advance of weakening economic conditions, they will recover well ahead of an economic recovery. Investors that attempt to time markets movements often wait until the “coast is clear” to deploy capital, but history shows this approach often results in investors buying high and selling low, the opposite of a successful investment strategy. We prefer to remove emotion from the investment process, use fundamental analysis to find investment opportunity, and patiently deploy capital as prices become attractive.
One more thing: our portfolios were not immune to market pressures. However, losses within investment portfolios allowed us the opportunity to respond in a way that still benefits you: tax loss harvesting. Within non-retirement accounts, U.S. tax law allows investors to use positions sold at a loss to either:
- Offset realized gains or
- Offset up to $3,000 of ordinary income.
Losses not used in the current year can be carried forward to future years until they are exhausted. During our routine process of rebalancing your portfolios, we included a procedure to check positions for losses that could be harvested toward future gains and income. Those investments were sold and replaced with similar securities to ensure we maintain our preferred asset allocation. While the amount of realized losses will vary from client to client, even those with limited losses were able to rebalance their portfolio without incurring additional tax liabilities, a rare opportunity.
Securities offered through Purshe Kaplan Sterling Investments, Member FINRA/SIPC Headquartered at 80 State Street, Albany, NY 12207.
Purshe Kaplan Sterling Investments and Benedetti, Gucer & Associates are not affiliated companies.