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Well, 2022 was quite a test. Even historically great fourth quarter stock market performance could not remediate earlier losses. It was a tough year for investors to maintain the discipline necessary for long-term investment goals, but our strategy yielded many silver linings with the late momentum teeing up a promising start to 2023. Perhaps not surprisingly, our economic themes for the New Year include inflation, Federal Reserve activity, international financial markets, and the perils of assuming “this time, it’s different.”
Before we dive in, let’s review an important topic: the link between the economy and the stock market. These two concepts are not the same, although talking heads consistently discuss them synonymously. The economy represents total output, including production and consumption, for a specific region or country, over a specific period in time. It is a steamship of aggregate decisions by consumers, businesses, and governments to allocate scarce resources. It’s reported in arrears, indicating what has already happened. Past tense. The stock market represents ownership of companies’ future earnings. Key word: future. Every day, billions of trades are placed to determine the price for those future earnings. For every buyer, there is a seller, each armed with their own transaction rationale. The stock market is a leading indicator of the economy, signaling an increase or decrease before the economy registers its impact. Too often people look to the economy to predict the stock market, or believe they are the same. Considering these two separately throughout 2023’s news cycle will ensure the data is viewed with the appropriate lens. Now, let’s cut through the noise and review the relevant points.
Q4 2022 provided a historic rebound, though 2022 final results were the worst since 2008.
Key market observations from 2022:
2022 was a reminder that using a crystal ball is a good way to end up walking on glass shards. The U.S. stock market had the worst year since 2008 while unemployment is historically low and GDP was positive. The Fed took rates from near 0 to 4% in 12 months. International stocks beat the U.S. in a year when Russia invaded Ukraine. Remember - markets are smarter, in aggregate, than any of us. Discipline and diversification are imperative to executing your plan and capturing months like October. If it was possible to consistently predict the future, we’d all own an island by now.
The dollar is historically strong, but less so than in September. The strength of the U.S. dollar is often politicized, twisted into a statement about the strength of the country itself. “Strong” must be good! “Weak” must be bad! This simplification is simply not accurate. International finance is relative to currencies and price of goods across borders, and there are pros and cons to all angles. If the dollar weakens in 2023, it may be a good thing. Part of the GDP equation is net exports (exports minus imports). If the dollar is weaker relative to other currencies, U.S. travelers pay more for goods and services abroad. BUT, those currencies can buy more from the U.S., driving more exports and adding to GDP – a net positive for the economy.
The Fed will likely raise rates incrementally in 2023, though inflation looks to have peaked in the fall. Inflation is still higher than ideal, but it has tempered significantly, and December CPI actually decreased from November. Consumer behavior has normalized, and commodity prices calmed. Labor supply and service prices remain an issue, so those areas will be scrutinized for improvement before rate increases cease. Regardless, remember that the Fed only controls the Fed Funds Rate, which is the overnight lending rate between banks. That’s it. Every other interest rate is market driven, including treasuries, mortgages, car loans, municipals, etc. So, news emanating from the Fed is only one part of the full interest rate picture.
As one well-known investor once said, ‘you make most of your money in a bear market, you just don’t realize it at the time.’ 2022 tested our resolve, and those who stick to the plan will have the best chance to succeed. We look forward to a great 2023, and please let us know of changes to your family’s personal headlines!
Sources: 2022 Index Returns dimensional.com, Zack’s Investment Management Q3 Earnings Exceed Expectations 11-21-2022, wsj.com An Epic Dollar Rally Goes Into Reverse—and Investors Expect Further Declines 12-29-2022, wsj.com The Dow Just Notched Its Best Month Since 1976 11-1-2021, First Trust How Stocks Fared This Millenium 1-5-2023, Federal Reserve Board of Atlanta GDPNOW 1-10-2023, BLS.gov, wsj.com Inflation Eased in December 1-12-2023
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