This investing year reminds me of my first driving lesson. When I got in the car for my lesson, I naturally assumed that the instructor would take me to an empty church parking lot for some easy and safe maneuvering. Instead, in a complete surprise, he directed me to enter New Jersey’s perilous Route 22 highway in Union County. This dicey section of highway is the state’s version of Talladega raceway with many sharp bends, haphazard U turns and combative “drivers”.
This inaugural test drive is not unlike the investing year ’22, with little room to hide including twists and turns like the highest inflation in four decades, double digit losses in both stocks and bonds and a war in Ukraine to name a few. Just like scary driving reps eventually make one a better driver, investing-wise, you must survive a lot of scary, volatile headlines and headwinds in the short run to achieve success over time.
Here are some charts and graphs on consumer sentiment, the economy, inflation and markets to better understand the road taken in 2022 and the investing route ahead:
Sentiment: It can’t get much worse. We have been in a consumer sentiment recession for months now. The media chatter plus endless talk about a looming recession are driving the doldrums. This lowly sentiment has spread to the corner office as well. In fact, 98% of CEOs expect a recession to hit the U.S. within the next year or so.1
The chart below shows the depths of the current sentiment reading which rivals the Great Financial Crisis of 2008. However, the chart also highlights that this lowly sentiment reading has proven to be a bullish stock market indicator over the next year.
Source: JP Morgan Asset Management
Economy: It's not a question of if but when we dip into a recession. Despite what all the financial talking heads allegedly know, what is impossible to figure out is exactly when we enter a recession, for how long and how much the economy contracts. I monitor the Atlanta Federal Bank GDP tracker which can be a fairly accurate measure of current economic activity in the U.S. As shown in the chart below, the tracker shows Q4'22 real GDP in the +3.2% range, so not near recession levels.
However, expectations grow for an economic hard landing, higher interest rates by the Fed and stubborn inflation, which we know and the stock market is pricing in. Implement an investment strategy that considers A recession and not THE recession and avoid changing portfolio course based on predications, guesses or hunches.
The Markets: A difficult year for both stocks and bonds with the S&P 500 down 13%2 and diversified bonds down 11%2. However, there are pockets in the stock market that have performed much better than the broader index. The value side of the market led by consistent dividend paying stocks continue to outpace growth stocks. In fact, year-to-date, value stocks are down a more modest 5%3 while growth stocks have dropped 24%3.
Given the magnitude and duration of outperformance by growth stocks leading up to this year, I continue to expect dividend paying value stocks to outperform higher valued growth stocks. This type of outperformance can last for years as the chart below highlights.
Market Outlook: Beating back inflation. The table below shows 10-year U.S. stock and bond market return assumptions by leading asset managers. The average stock market forecast of 7.6% is about a half the annual S&P 500 index return over the last 10 years. This average return estimate is reasonable given the extraordinary stock market returns in the decade leading up to this year.
A key variable with these returns is the assumed inflationary environment. If inflation stabilizes in the 4-5% range, then using a +4.4% average U.S. bond market return, one is not making money after inflation. That is why stocks have historically been and can be one of the best inflation beating investments, especially dividend paying stocks.
Intestinal Fortitude: Your Most Important Investing Organ. Many believe the brain is the best tool in our investing toolkit. However, this year is a good reminder that the stomach is the most important investing organ we have. The chart below reinforces that this is especially true in highly volatile, stomach-churning markets.
Portfolio. Pistons. Pendulum.
In an investing year filled with sudden air pocket drops and subsequent sharp rallies, its been an unsettling ride for many investors in ’22. Sometimes you have to survive a lot of bad news and volatility in the short term to get to your destination safely over time. Returns in just one year don’t really add up a whole lot over the long haul even if it makes you feel awesome or awful.
A suitable, diversified portfolio has numerous investment pistons in its engine. They move up and down to keep the portfolio going onward and upward over time. This year is a reminder that diversification is essential. Having high growth technology stocks counterbalanced by consistent dividend value stocks helps deal with the uncomfortable times in the market. Keep calm and invest onward in 2023.
David Hone, CFA
1 Measure of CEO Confidence. The Conference Board Q4’22
2 S&P 500 index YTD thru 12-13-22
2 iShares Core US Aggregate Bond ETF YTD thru 12-13-22
3 Russell 1000 Value & Russell 1000 Growth YTD thru 12-13-22