2022 4th Quarter Market Commentary
A Special Thank You.
To all of our clients and friends of Patina, we would like to take a moment to thank you for your continued support. While 2022 was a challenging year for markets, we were able to grow our business by over 40%. Most of our growth comes from client and friend referrals, which we appreciate very much. We plan to continue to build your trust by working hard to deliver top-tier service levels and performance. We believe that our dynamic asset allocation approach, where we look for rebalancing opportunities across equity sectors and bond durations, was a big value-add during 2022. We think this type of active approach will be critical going forward as we’re likely to see continued heightened volatility and inflation. Best wishes for a happy and healthy new year.
Top Headline for Q4: Light at the End of the Tunnel?
Markets were at the mercy of the U.S. Federal Reserve Bank (the “Fed”) for most of 2022. With inflation running higher for longer than expected post COVID, the Fed aggressively increased interest rates throughout 2022. After starting the year with the Federal Funds Rate near zero, we finished 2022 with a target rate of 4.25-4.50%, representing one of the fastest rate-hiking cycles ever. Predictably, equity and bond markets sold off hard in response to the rate increases and rallied with each perceived pause. However, markets now see some light at the end of the tunnel and are predicting that we’re near the “terminal rate” level (i.e., the highest Federal Funds Rate before a rate decrease occurs). As the table below shows, the Fed has slowed the pace of hikes and has admitted that they are nearing the end of the increases. While a few more small increases are expected, the key question is how long rates will be held around current levels should we enter a recession or see continued equity market pain.
Schedule of 2022 rate hikes by the Federal Reserve Bank.
When looking at winners and losers from 2022, it’s a predictable story based on interest rate movement. On the equity side, as would be expected, the higher interest rates punished growth (e.g., the large cap value ETF (SCHV) was down only around 7% while the large cap growth ETF (VUG) fell over 33%). On the bond side, “long duration” assets were hurt the most having one of their worst years on record.
While the equity market drops tend to get a lot of headlines, it’s the volatility in the bond market that is the most historically noteworthy. The whipsaw from COVID shutdowns to COVID economic stimulus, followed by spiking inflation and aggressive Fed action, battered the bond market and added near record levels of volatility. For example, after starting the year around 1.5%, the 10-year treasury bond yield spiked to over 3.5% in June before falling to around 2.6% in August only to spike again to over 4.2% in October and finish the year just under 3.9%. This is an incredible amount of volatility in a short period of time and highlights the uncertainty around inflation and interest rates throughout the year.
General Market Update
US Equities: 2022 finished with the S&P 500 Index down 19.4% and saw all equity sectors down except for Energy. Not surprisingly, the big winners from the 0% interest rate world proved to be the big losers as rates climbed and liquidity tightened. For example, as measured by the SPDR ETFs, technology, consumer discretionary, communications and real estate faced declines in the 25-40% range. Moreover, all of the previously invincible tech behemoths (i.e., Meta f/k/a Facebook, Apple, Amazon, Microsoft and Google) all faced massive declines led by Meta, which was down over 64% for the year.
The equity market seemed to stabilize a bit during Q4 as quality value names gained ground. The S&P 500 Index was up 7.1% during the quarter, while the Nasdaq Composite was down 1.0% and the Russell 2000 Index climbed 5.8%. The divergence in equity sectors throughout 2022 provided an opportunity for Patina’s dynamic sector weightings, and we were active in rebalancing throughout the year. Portfolios benefited from a heavier sector weighting toward “Value” sectors such as Energy, Financials, and Industrials, as well as sub-sectors such as Oil & Gas Exploration and Oil Services.
International and Emerging Market Equities: After taking a beating in recent years relative to the US equity market, international markets appear to be stabilizing and outperforming in recent periods. The Schwab International Equity ETF (SCHF), which holds stocks of developed markets excluding the United States, was up 16.7% in Q4, and the Schwab Emerging Markets ETF (SCHE) was up 8.3%. Energy inflation issues plaguing Europe have subsided a bit, and the “re-opening” of China should provide a continued boost for emerging markets. Moreover, the US dollar may have reached a near-term peak relative to foreign currencies which would provide an additional tailwind for non-US markets. Lastly, foreign markets have benefited relative to the U.S. for having a lower allocation to “growth” names.
Fixed Income and Credit: 2022 was a brutal period for fixed-income investors. Fraught with extreme volatility, the bond market endured one of its worst years ever. For example, the long-term corporate bond market, as measured by the ETF VCLT, was down over 25%. However, while volatility remains, the long-term bond market seems to have ended its rapid descent with VCLT up 5.0% during Q4. We were successful in generally predicting the bond market route, and throughout 2022 Patina clients benefited from a substantial overweight to shorter-duration bonds. As an example, the short-term corporate ETF, VCSH, was down 5.6%, significantly outperforming the previously mentioned long-term corporate bond ETF.
Commodities, Precious Metals, Inflation: Real assets and inflation hedges will continue to play a role in investor portfolios in the coming years. While the post COVID inflation spike seems to be dissipating, economists continue to debate where long-term inflation expectations will land in the coming years. In a bit of good news, the last two Consumer Price Index (CPI) reports for 2022 both came in slightly below expectations, thus giving investors a sense of optimism heading forward. It was noteworthy that the gold ETF (GLD) was up 9.7% during Q4. This movement was unexpected as “real yields” were up during the quarter across the entire bond curve – an environment that typically leads to falling precious metal prices. Global investors may be beginning to question how governments are going to pay for budget deficits and underfunded obligations (e.g., social security) without currency devaluation.
A Look Ahead
The “Fed Watching” is likely to reach a crescendo in 2023. It seems clear that we’re near the terminal rate which should help equity and bond markets stabilize. However, equity markets could face continued headwinds if rates remain at elevated levels versus having an actual “Fed pivot” (i.e., a reduction in rates). Moreover, there is a lag on rate increases hitting corporate margins, and a rough patch for US corporate earnings is expected during 2023. We will be closely watching for heightened volatility as we enter 2023 but anticipate increased stability as we exit 2023. With the increased volatility and continued uncertainty, choosing the right sectors and factors and taking advantage of rebalancing opportunities will be more important than ever. We are excited about the opportunities ahead in 2023.