For the second consecutive year, predicting the rate of inflation should prove to be the most important variable for investors to consider as we enter 2023. During the holiday season of 2021, the Fed’s median projection for the upper bound of the Fed Funds Rate for year-end 2022 was 1%, with the terminal rate forecast to ultimately reach 2.5%. Investors were happy with those estimates and stocks exited 2021 trading comfortably north of 20X forward earnings. The world then changed, causing most investors to suffer sizeable losses during 2022. In this note, we will review last year, discuss the performance of our funds and table our outlook for financial markets during 2023.
This year’s U.S. Thanksgiving was no turkey for investors as the price of pretty much everything, other than energy commodities, moved sharply higher. There were three drivers catalyzing this fifth beta rally during an otherwise tough year for investors: October’s softer-than-expected U.S. inflation data, soothing words from Fed officials, and the positioning of investors. The key question is whether this latest rally is another headfake, or does it constitutes a sustainable bounce off the bottom. Before tackling this question, let’s review the performance of our funds.
Based on the aspiration that the timing of the Fed’s inevitable pivot may occur before year-end, perhaps as early as last week, equities enjoyed a huge move higher during the month of October. Unconvinced that various macro variables had yet to advance from flashing yellow to exhibiting the all-green, our funds remained conservatively positioned. While frustrating to the team in light of the big bounce in equities, given our long-term net returns, we’re cognizant that protecting client capital during this exceedingly rough 2022 has been top-of-mind for our investors. Hence, we will continue to aim to be the tortoise versus the hare. After discussing last month’s results, this note will update our views on the outlook for markets and the positioning of our funds.
In light of the growing stagflationary environment, investors experienced the full brunt of the renewed downside correlation between stocks and bonds during September, historically the worst month of the year. For the first time since 1938, the S&P 500 closed the quarter with a negative return (-5.28%) after earlier rising more than 10% (+14% July through mid-August gain) as breadth turned strongly negative during the last month of the quarter. In fact, to highlight what has become a year-to-date trend, 56.4% of all trading days during 2022 have shown declines for the SPX, including 26.1% of those days featuring declines of at least 1%. Perhaps even more startling, the Nasdaq-100 and long-term US Treasuries are both down by roughly 30% since the start of January and yields on U.S. 10-year bonds hit 4% for the first time since 2010.