By David MacLeod, CFP®, CFA

Amid a dramatic rise in interest rates, stocks and bonds posted negative returns in 2022. U.S. stocks reversed strong 2021 returns with the S&P 500 Index down 18% for the year, returning to prices last seen in March 2021. Below the surface of that average was a wide disparity across various sectors and styles of investing. Technology stocks were hurt the most with significant losses across the board including stocks such as Facebook/Meta (-64%), Netflix (-51%), and Amazon (-49%). Value stocks performed relatively well and were down less than 10%, on average. In fact, many had positive returns for the year including Johnson & Johnson (+7%), Coca Cola (+10%), Raytheon (+20%), and Exxon Mobil (+81%).

Bond yields jumped as the 10-year U.S. Treasury bond yield closed at 3.9%, up from 1.5% at the start of the year, leading to negative returns for bonds and bond funds. Losses in bond funds were mainly due to the rise in interest rates, rather than an increase in default rates. We expect bond fund losses to be made up over time. As bonds held inside a bond mutual fund mature, they get replaced with the higher yielding bonds being offered now. Current yield is an excellent indicator of future 5 to 10-year returns so we have a higher expected return for fixed income portfolios today than we did at the beginning of 2022.

As inflation pressure begins to ease, the economic outlook for 2023 depends a lot on how much the Federal Reserve further tightens monetary policy through additional interest rate hikes and balance sheet reductions. The market expects that the Federal Reserve will raise interest rates by 0.25% three more times, before pausing. There may be a temptation to hit pause sooner if technology sector layoffs accelerate and retail sales numbers weaken. For now, unemployment remains very low and in the 4th quarter U.S. Real GDP probably grew at a healthy rate.

Looking ahead, we continue to recommend staying the course with a disciplined approach to investing. We do not recommend attempting to time the stock market around recession probabilities. We don’t know if stocks will continue a downward patten or rebound this year. Statistically, the S&P 500 averages a 9.2% return in the year following a down year, only slightly lower than the average for all other years. It’s also worth highlighting that the stock market tends to bottom six months before the unemployment rate peaks in a recession. As the old Wall Street saying goes, “nobody rings a bell at the bottom.” Since the recent market bottom in late September, stocks have rebounded by 8-10%.