2022 Review – THEME: Tug of War Between Earnings Tailwinds and Valuation Headwinds
Global financial assets experienced near record volatility in a generally hostile environment for investors given that the Fed and other central banks left themselves exposed to a rise in inflation as we cautioned in our year ahead outlook for 2022.
2022 was the first year in nearly fifty that stocks and bonds both had negative returns for the first three quarters. At the beginning of the year, we expected a down year, but not a 25+% bear market. Equity market performance was mostly driven by valuation compression as bond yields adjusted sharply higher in response to elevated inflation and monetary policy normalization by the Fed and other central banks. The P/E ratio of the stock market peaked at 22x at the January 3 high and fell to a low of 15x at the October 12 low. The Bull/Bear Ratio (BBR) fell to a bear market low of 0.57 in mid-October. Historically, BBR readings of 1.00 or less have offered great opportunities for long-term investors. Sentiment continued to lean risk-off on hawkish takeaways from central bank speeches and increasing growth fears. The path of least resistance was lower for most of 2022 with bounces repeatedly reversed by Fed pushback against occasional easing of financial conditions and expectations (or hopes) of a Fed pivot.
Other major observations from 2022 include the massive outperformance of value over growth and defensive over cyclical stocks. Energy stocks behaved as if there was no bear market at all. International stocks eked out outperformance over the U.S. despite China’s zero-Covid policy and the ugly Russia-Ukraine war. The strong showing of Democrats in the midterm elections surprised most pundits.
The key economic question for 2023 is whether central banks will be able to bring down inflation to acceptable levels without a recession. Beyond the inflation dynamic, we remain concerned about potential political and economic shocks that could impact the U.S. and global economy via higher uncertainty and/or tighter financial conditions. It is with this backdrop that we proceed as usual with fear and trepidation (and hopefully some good educated guesses) to unveil our prognostications for 2023 in the form of the Ten Predictions.