Fourth Quarter Market Review
“Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply, and to sell wisely when they advance a great deal. At other times, he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.” – Benjamin Graham, The Intelligent Investor
Annus Horribilis. Investors will be happy to see 2022 in the rearview mirror. While the stock market has shown a propensity to go up over time, 2022 reminds us that global markets don’t go up in perpetuity and can go down in unison. As it has always been, volatility and downward markets are the admission prices paid for successful long-term investing.
The S&P 500 produced a -18% total return in 2022, while the tech-heavy Nasdaq experienced its worst decline since 2008. This decline was almost entirely driven by multiple compression in the price-to-earnings ratio as the S&P 500 index’s forward price-to-earnings ratio declined from 21.3x to 16.7x over the course of the year. Looking back over history, this was the 7th worst return for the S&P 500 since the 1930s. Nevertheless, there was a bright side as global stocks snapped a three-quarter losing streak, as October and November provided nice upside before December’s decline. Commentary around the Federal Reserve pivoting to a more dovish policy stance, coupled with softer inflation figures, easing supply constraints, and declines in prices for items like used cars and rent, led to the market rally early in the quarter. Market leadership was driven by large caps, while defensive sectors (energy, materials, industrials, health care, and consumer staples) continued to outperform the broad market.
Fixed income returns were equally disappointing in 2022, with the Barclay’s Aggregate index down 13% in 2022. Our data for the index goes back to the 1970s, and since then, the index has only been negative four times, with no year down more than -3%. U.S. Treasuries also suffered, as the Fed’s rapid rate hikes coupled with yield curve inversion (shorter end of the yield curve higher than the longer end) impacted markets. If there is a silver lining, it is higher yields. While investors lamented the lack of income in portfolios just a year ago when yields were close to 1.5%, now short-term debt is yielding 4% to 5%, significantly higher than we’ve seen in years.
While 2022 should be viewed as a sunk cost for long-term, diversified investors, some things that keep us quite optimistic as it relates to the upcoming year. Research provider, FactSet, recently stated that back-to-back down years for U.S. equities are fairly rare if we look back in history. Going all the way back to the 1930s, the last time we had back-to-back down years happened in 2000-02, while before that was 1973-74, 1939-41, and 1929-1933. Jefferies has noted that following years in which the S&P fell ~20%–which it did before the fourth quarter’s rebound—the market has tended to bounce back. The research firm pointed out the last three times the S&P was worse than this past year, it returned over 20% in the following year. It’s also important to keep in mind that in 2019, the S&P 500 was up 31%; in 2020, it was up 18%; and in 2021 it was up 29%. In many ways, a resetting of valuations was warranted and necessary to find ourselves earning higher returns. The good news is that when we’ve had years like 2022, it’s historically been an advantageous time for long-term investors as valuations are lower and future returns potentially higher.
As long-term investors, our job is to have the patience, perspective, and temperament to realize things change, and adaptability is key. The legendary investor Ben Graham’s quote rings just as true today as it did in 1949. While 2022 was challenging, to say the least, we know that future returns for many asset classes have now become much more attractive. We will continue to focus on what’s in our control—to take the long-term perspective…focus on the operational excellence of the firms in which we invest and the associated cash flows they accumulate…analyze the prowess with which they deploy that capital on behalf of our clients and their goals, etc. We arm our clients with data and analysis to make informed and wise financial decisions for them and their families. These are within our control. In the end, whether the market rebounds or falls further is up to the “bear.” How we respond is up to us.
We wish our clients and friends a happy, healthy, and prosperous new year. We value your trust and confidence in Madison and look forward to supporting you in reaching your goals.