2022 Annual Review – Everything Will Be Okay

Ouch.  Let me be the first to admit I thought we had another six months to a year before the markets woke up from their years-long drunken (on easy money) binge.  After all, 2022 began the year with a strong labor market, easy money and record low interest rates, and Elon Musk still wealthy (I hear ramen is in short supply in his area).  Yet even after last year’s thumping, investors in equities have still been well compensated, with the S&P 500 10-year annualized total return through the end of 2022 at 12.7%!  It wasn’t smooth (remember the Pandemic?) but if investing in stocks was easy, expected returns would be closer to those of cash.  And while stuffing cash under your mattress is indeed one approach to investing, it’s not generally the best strategy if you’re not an actor in Breaking Bad and you have more than a few months investment horizon.  So even though 2022 was unpleasant and a bit premature based on my cracked crystal ball, it was a good reminder of why we expect higher returns for the risk in equities.  Fortunately, while elevated volatility will likely continue through at least the first half of this year, as I wrote in October of 2022, there are signs of a recovery under way. 

On average the stock market finishes a calendar year down once out of every four years, and while not necessarily overlapping, the markets also tend to experience a 20% selloff once every four years.  Even with the averages well known, despite having only two down years since 2003, few of the “experts” on The Street predicted a downturn, let alone one of this magnitude. In fact, JP Morgan, Citigroup and Goldman Sachs (full disclosure I’m a former employee of GS), companies teeming with CFAs and PhDs, all guessed that the markets, down 20%-30% for the year depending on the index, would actually end the year up!  

“But I only invest with the winning stock-pickers” Or, one of my favorites, “Why would I invest in broad indexes, I’ll never beat the market.”  Right, good thinking.  Back in the real world, there are some stock pickers and market timers who will beat the market, but significant data shows that we don’t know how to identify which ones will do so in advance of them doing it, and looking backward at someone who outperformed last year is statistically not a good indicator for who will outperform this year!  In fact, it was this research, specifically from work done by Michael Jensen published in 1968, that led to the creation of index funds!  In the words of a great 90s rapper, “It’s hard out there for a…stock-picker.” I think that’s how it went.  

Predictions for the bond markets weren’t much better.  For those who successfully avoided looking at your detailed investment returns (I affectionately refer to you as ostriches), the average bond index was down over 12% in 2022.  Yet according to Consensus Economics, “The average forecast [in December 2021] for [December 2022’s] interest rate was just 0.5%!” The Fed ended the year with short term target interest rates (a loose definition for the fed funds rate) in the range of 4.25% to 4.5%.”  

Fortunately there are reasons to be optimistic. 

• Investor sentiment stinks!  In fact, it’s the worst on record since 2008 – and that’s great news!  A quick look at any chart shows this looks like it might have been a decent time to put some money to work!
• Investors who kept buying through – and held through – the flat decade of the 2000s, which includes two of the three worst bear markets in U.S. history, ended up doing pretty well. For perspective, the bear market of the early 2000s reached as low as 776 and the bottom of the ’07-’09 bear market reached an even lower low of 676.  Today we’re jumping around 4000, up almost six times from it’s lows of 2009.
• Inflation seems to have peaked, which indicates the Fed may be slowing the pace of interest rate hikes.
• Since 1936, of the 9 prior-to-2022 years with double-digit losses, seven of them experienced double-digit gains the following year.  The average of the subsequent year returns was 18%.  (source: Indexology: Anu Ganti)
• There has never been two consecutive years of declines in both the stock and bond markets (there seems to be some complex dispute to this so while I’ll note the dispute, further discussion is outside the scope of this article and doesn’t support my argument so let’s go with it). 

I’m not saying the markets will turn around this quarter (I don’t believe they will with the debt ceiling debate on the horizon), but I believe the stage is getting cleared for the next act, and that moving money back and forth to the sidelines, or trying to pick stocks or sectors that outperform in certain market conditions is not a recipe for success.  

In the words of Sir John Templeton, “Bull markets are born on pessimism, grown on skepticism, mature on optimism, and die on euphoria.”  

Fortunately for long-term investors, things look pretty bad – and that’s a little bit of good news!