2022 Q4

In 1981, my grandmother set aside money into Certificates of Deposit for me to pay for college after I graduated high school. I wound up being a benefactor of Paul Volcker’s mission to rid our economy of inflation in the early 1980’s. Most of us can remember the meteoric increase in interest rates undertaken by Volcker, the Federal Reserve (Fed) chairman at the time, to curb inflation. The economy was negatively impacted, inflation was brought under control, and the 12% interest rate I received on those CDs paid for my college.

As we entered 2022, we knew that the Fed needed to aggressively address inflation once again. While we have been arguing for years that the Fed was keeping interest rates too low for too long, its inaction caught up with them. Without question, 2022 will be remembered for the Fed’s sledgehammer approach to taming inflation. It also appears to be the beginning of the end to the largest monetary and fiscal “experiment” in history.

Equity markets faced significant headwinds last year. The S&P 500 was down almost 19% for 2022, and the NASDAQ was down almost 33%, reflecting the Fed’s actions. What was unusual for the year was the negative impact to fixed income investments. While we typically see a move into fixed income investments when equity markets are down, which would lead to higher prices, the Fed’s policies created the worst bond market in 40 years (since Paul Volcker’s era). Fixed income was down over 13% as measured by the iShares Core Aggregate US Bond index ETF. Because of the potential tightening by the Fed, we adjusted our fixed income even further at the beginning of the year to lessen the impact of its actions.

For 2023, it is less likely to be about interest rates, and more about the lagging impact to the economy of the Fed’s policies and inflation. While we had expected that the Fed would not want to intentionally put the economy into a recession, this unfortunately appears to not be true. The question is still open if we will have a recession or not. If we do, we do not expect the magnitude to be anything near the Great Recession. Additionally, if history is any guide, equity markets typically bottom well before the economic cycle trough, and may coincide with the ending of the Fed rate increases, which we see coming to an end in the first half of the year. Market volatility will probably still be an issue until the Fed stops its course of action.

We are pleased that our protective stance in fixed income, and our equity allocation in our stocks, led us to have much better performance than the indices stated above. I understand this is relative because it was all down, however these positions, along with our taking advantage of reallocating investments as the markets receded, put us into a better position when markets begin their sustained move upwards. We will continue to look for opportunities created by market volatility to advance the equities in our portfolios. We also will look to continue to adjust some of the fixed income positions we have been utilizing to take advantage of the changing inflation/interest rate environment.

We look forward to a great 2023 and as always, thank you for your continued trust.

Marc Henn, CFP®