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ACM Journal - Investment Management
13 Jan

Portfolio Review – Q4 2022 Newsletter

Stock and bond markets enjoyed some relief to close out 2022 after dismal returns for most of the year. The S&P 500 gained 7.6% for the fourth quarter while the Bloomberg U.S. Aggregate Bond Index rose 1.9%. Despite the rebound, 2022 was one of the worst years for both bonds and the traditional 60% stock/40% bond portfolio in recent history.

Changing Leadership

The past decade was similar to the Tech Boom of the 1990s in that technology, communications, and consumer discretionary stocks performed exceptionally well. However, stock market leadership changed in 2022 and these sectors were among the worst performers this past year. Given their high valuations coming into the year, it’s hardly a surprise they underperformed relative to other portions of the market during a general stock market selloff. Conversely, stocks in the consumer staples, utilities, and energy sectors held up much better this year after performing relatively poorly in the prior decade. Energy was without question the best performer this year as the S&P 500 Energy Select Sector Index returned almost 65%.

2022 also marked a significant change in the performance of value vs growth stocks. While growth had been dominant in the prior decade, value stocks outperformed growth stocks by 26% in 2022, as represented by the S&P 500 Pure Value and Pure Growth indices. This is the best relative performance for value since the Dot-Com Bubble burst in the early 2000s. Despite recent strong returns, value remains far more attractively priced than growth stocks, and we would not be surprised to see value stocks outperform for several more years. Looking at other factors, low volatility and small-cap stocks both outperformed the S&P 500, while momentum and quality showed little difference from the index. Domestically, all five factors outperformed in the fourth quarter to end the year.

Developed international stocks bested US stocks for the fourth quarter and full year 2022, returning 17.3% for the quarter. International stocks have lagged their US brethren for many years, but the tide may be turning. A weakening US Dollar and far more attractive valuations overseas could lead to stronger performance in international stock markets, particularly the emerging markets which trade at very low levels relative to their historical valuations.

4th Quarter 2022 Asset Class Returns

Beyond Stocks

Bonds suffered their worst performance in at least the past hundred years. The Bloomberg Aggregate Bond Index fell 13% last year because of the rapid rise in interest rates. Shorter duration bonds were more defensive and reduced much of the overall bond market’s loss. While there may be additional downside because of the continued uncertainty in interest rates, the Fed, and inflation, the return potential on bonds given today’s yield is much greater than one year ago.

Alternative investments were the big winners in 2022. All the strategies we employ outperformed the broad stock and bond markets, while managed futures and style premia each returned over 30%. These strategies have very different return characteristics than traditional stocks and bonds, which offers a high degree of diversification. That can be a liability when stocks are rising rapidly, but it was a huge benefit when both stocks and bonds fell.

Economic Landscape

The economic forecast is mixed going into 2023. Year over year inflation, while still much higher than the Fed’s target of 2.0%, has been trending downward recently. Despite recent layoffs made by some larger companies (Amazon, Goldman Sachs, Meta, just to name a few), the unemployment rate has decreased from 3.9% a year ago to 3.5% today. Factoring in these data points, the Fed will presumably be less aggressive in its interest rate hikes in 2023. Fed watchers and economists are concerned an aggressive Fed will push the economy into a recession. However, continued strength in employment would make for a much softer landing than many anticipate.

That said, other indicators signal a recession may be imminent. The US Leading Economic Index is flashing a recession signal. A recent Bloomberg survey had the probability of a near term recession in the US rising to 65%, with the UK and EU at higher odds. The inversion on the yield curve between 10-year and 2-year Treasury bond yields, which has been a reliable recession indicator in the past, has continued to widen. In fact, yields on 1-month Treasuries are currently higher than 30-year Treasuries.

Based on these conflicting signals, it is difficult to determine if the economy will hold up and markets will continue to rally or if tougher times are ahead in 2023. Uncertainty and risk are unfortunately part of the investment experience, and there is no known way to avoid them. Despite losses, our portfolios held up quite well relative to the overall stock and bond markets in 2022, and we believe we are well positioned for the future. We expect broad diversification will be the key to solid returns in the future.

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