2022 Q4 Market Commentary: Surprises
“The correct lesson to learn from surprises: the world is surprising.” - Daniel Kahneman
The last few years have been full of surprises in the investment markets. In 2020, we had a global pandemic that shut down the entire world and sent markets into a massive drawdown for about a month. We then saw markets skyrocket back to new highs despite the ongoing pandemic. In 2021, speculative investments like cryptocurrencies, meme stocks, and SPACs all shot through the roof, and the overall market posted exceptional returns with very little volatility. Then 2022 came around, and the market euphoria since April 2020 came to a grinding halt.
The Federal Reserve raised the benchmark federal funds rate at its fastest pace in history, with seven interest rate hikes, bringing the effective rate to a range of 4.25-4.5% from 0% in January. This extremely fast rate spike led to the worst year we’ve seen for bonds in modern history, as the Barclay’s Aggregate Index fell about 13%. Bonds weren’t alone this year, as nearly every category of stocks also saw a decline. Large-cap US stocks were down 18%, small-cap US stocks were down 20%, international stocks were down 15%, and REITs were down 25%. The only real bright spots were in commodities, with the Bloomberg commodity index up 16%.
These numbers would have been much worse if not for a strong 4th quarter that saw a rebound in both stocks and bonds. Large-cap US stocks finished the quarter up 8%, while international stocks rebounded over 16%. Even bonds posted positive quarterly returns, with the Barclays Aggregate up about 2%.
The strong 4th quarter numbers aren’t the only positive thing we can take away from 2022. The sharp increase in interest rates might have been painful for bonds this year, but this might have been like ripping off the band aid to avoid prolonged pain. With yields now at much more “normal” levels, the bond side of your portfolio can finally generate some income, and there is room for the Federal Reserve to cut rates should they need to. Further rate hikes are likely in early 2023, but the size and speed of those hikes are expected to slow down.
On the stock side of the portfolio, valuations look much more attractive than they did at the beginning of the year. The S&P 500 is right around the 25-year average forward P/E ratio, according to J.P. Morgan. That’s not to say stocks can’t fall further from here, but long-term expected future returns are generally higher when valuations are lower.
Even though 2022 was a difficult year for most investment portfolios, you can see there are reasons to be optimistic. We can also reflect on a difficult year and learn from the experience. Here are a few lessons we took away from the year.
Stop being surprised
The natural human response to a surprise is to figure out how we were surprised so we can prepare for the next time. Unfortunately, next time the surprise will be something different that you haven’t prepared for! The appropriate response isn’t to prepare for the last surprise but to prepare to be surprised. As Kahneman wisely points out, the correct lesson to learn from a surprise is that the world is surprising.
Everyone knew interest rates would rise this year, but most were surprised at how quickly they spiked. Inflation was a concern heading into 2022, but very few expected Russia to invade Ukraine, putting even more pressure on commodity prices. Technology stocks looked overvalued in January 2022, but not many expected them to fall as far or as fast as they did.
We shouldn’t look back on this year and prepare for a repeat of the same surprises. Instead, we should prepare to be surprised by something we aren’t expecting. This is why we continually preach the benefits of diversification. Being diversified means being prepared for whatever surprises the world throws at you.
It doesn’t matter how smart or rich you are
Elon Musk is undeniably a genius and one of the richest people in the world. Early this year, he started buying shares of Twitter and, in April, made an offer to purchase the entire company. While we don’t know the true value of Twitter now that it’s private, we do know that other social media stocks, like Meta and Snap, went down 60-80% on the year. Elon’s own company, Tesla, also declined by 73%. He picked a terrible time to buy the company and massively overpaid, as even he admitted.
Sequoia Capital is one of the world’s largest and most successful venture capital firms. They invested over $150 million into the cryptocurrency exchange FTX, run by Sam Bankman-Fried, who in August 2022 was called “The Next Warren Buffett” by Fortune magazine. FTX is now in bankruptcy, Sam is facing criminal charges of fraud and money laundering, and Sequoia had to write their investment down to $0. The company appears to have had little to no internal controls and a balance sheet that was so bad it seems like a child made it up.
We often try to tell ourselves we are smart enough to time the markets. We like to think that if we just spent some more time on research, then we could pick the next Amazon. These stories show that no matter how smart or experienced you are at investing, it’s still extremely difficult to time the markets and pick individual stocks.
What goes around usually comes back around
In my year-end market commentary last January, I talked about some of the long-term cycles we tend to see in markets, like US stocks vs. international stocks and value stocks vs. growth stocks. For years we had seen US stocks outperform international stocks and growth stocks outperform value stocks. In 2022, we finally saw those trends reverse, with both international and value stocks outperforming their counterparts. We won’t try to predict where they each go from here, but it is another example of why it’s important to have exposure to different types of stocks and asset classes.
For many investors, 2022 was a year they'd like to forget. It’s painful to see portfolio values decline, and we all wish markets did nothing but go up. Unfortunately, we know that isn’t possible. We need to be able to stick it out through the down times to be rewarded for the good times. Step back and reflect on what you learned last year. If you feel you need to make a change to your portfolio, schedule a time to discuss it with us.
-Chris Benson, CPA, PFS
The views expressed represent the opinions of L.K. Benson & Company and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person. Please see Additional Disclosures more information.