Review & Outlook
January 9, 2023
After 2021 ended the year with a bang, with stocks reaching their all-time highs on the very last day of the year, it’s an understatement to say that 2022 went out with a whimper. The S&P 500 posted a (-18%) return for the year while Carderock stocks were down (-23%), with a balanced 55%-35%-10% (Stocks-Bonds-Cash) portfolio down approximately (-15%). At this stage, we are focused on how disappointing results have presented long-term investment opportunities not seen in years.
With a long history of investing through bull and bear markets, we are acutely aware that major swings such as these are not uncommon…in stocks. Prior to 2022, there had been only four years since 1928 where Bonds and Stocks both posted negative returns for the year. Given that last year’s anomaly is explained by the Federal Reserve’s swift policy reversal of hiking rates from zero, we’re somewhat relieved to consider a reprint in 2023 unlikely.
Looking ahead, we expect 2023 to see a return to the virtues of participating in a balanced portfolio as the Fed nears the end of its tightening cycle. Though we are positioned defensively to start the year, we see more positive developments than what is currently expected among the general investment community.
Our View for 2023
The Economy
Inflation declines as supply chains fully normalize, corporations offload excess inventory through discounts and rents fall.
Commodities Deflation in oil, gas, timber and wheat since the onset of the Ukraine war will boost household incomes and construction activity.
Labor markets and wages remain robust as Baby Boomer retirements and declining immigration have led to a shortage of workers.
Capital Investment in battery technology, alternative energy and automation accelerate as Europe weans itself from Russian gas and corporations substitute capital equipment for labor.
A Soft (Slower Growth) vs. Hard Landing (Recession) depends on Federal Reserve policy, while typical preconditions leading to a significant downturn are non-existent (excess corporate investment, household debt, oil spikes).
Stocks
Quality Growth Stocks fare better than cyclical alternatives amidst slower growth and an interest rate hiking cycle near its peak.
Earnings Growth will track a tepid economic environment but decline less than what is anticipated by current stock prices.
Profit Margins continue to decline albeit from record levels.
Sector Divergence 2022’s barbell performance between Energy (up 47%) and Communications (down 41%) has opened opportunities to redeploy cash in 2023 across many down sectors, setting up a stock picker’s market.
Fixed Income
Interest Rates peak in 2023 as inflation data continues to come in soft and the Federal Reserve shifts to neutral from overdrive.
Carderock’s Low Average Maturity of roughly 2.5 years in our fixed income portfolios will allow us to take advantage of higher yields in 2023 as maturities occur.
Final Thoughts
Positive developments on inflation over the past several months have boosted Stocks off their 2022 lows. With a defensive 35% cash target in our equity portfolios to start the year, we are closely monitoring both the Federal Reserve’s reactions to economic data and earnings reports of our Quality Growth stocks for signs of a sustainably positive long-term trend. Good news is coming- it’s strictly a question of when.
We see 2023 as a year of normalization across stock and bond markets, as much of the post-pandemic speculative activity fades away and investors shift their focus back to highly profitable and quality businesses. With enough patience, you will be rewarded for sticking to the fundamentals and eschewing unsustainable fads.
As always, feel free to give us a call to review your investment progress or ask any questions you may have.
Warmest Regards,
Daniel A. Kane, CFA
President
James W. Mersereau, CFA
Portfolio Manager
Stephen F. Knapp, CFA
Director of Research and Quantitative Strategies
