Year in Review - A Stunning Turnaround

July 21, 2023

Year in Review – Twelve Months Ended 06/30/2023

Russia’s assault on Ukraine combined with strong consumer and governmental spending induced an inflationary spike that garnered most of the economic headlines. The Fed and other central banks struggled mightily against the inflation scourge. Data in 2023 displayed solid progress as the pace of price increases moderated. Expectations of an imminent recession were not realized. Investors could be forgiven for feeling confused as concerns oscillated throughout the year between runaway inflation and an economic downturn. Eventually, signs of diminishing inflation calmed the nerves and helped stocks stage a significant rally. AI mania captured the imagination of society and the markets. The collapse of several mid-sized banks had no long-term impact.

Major Economic Events

The post-pandemic global economic recovery decelerated rapidly. The US economy slowed, Europe shuddered from the impact of the Russian assault on Ukraine and the surge in energy costs, while periodic lockdowns in China depressed demand while snarling the supply chain and contributed further to the inflationary pulse. China’s abandonment of its zero-covid policy failed to generate additional inflationary pressures.

Employment worldwide was strong, and wages rose. Even as the supply chain snafus slowly resolved themselves, spending on services such as travel soared, providing additional fuel to inflation. The Federal Reserve began raising rates at a very rapid pace. Commodity price pressures eased during the 3rd quarter of 2022, which, in concert with the impact of higher interest rates, had inflation in a downward trajectory as the year drew to a close. So-called “core inflation” (overall inflation excluding food and energy) remained uncomfortably high.

The Equity Markets

Global stock markets took a beating in 2022, declining for most of the year. A rally that began in the 4th quarter continued into 2023 and by late June the market was firmly in bullish territory. The rise was not particularly broad based, however. Technology stocks were the standouts by a huge margin. Investor exuberance over the potential of artificial intelligence combined with what was already a favorable regulatory/competitive environment. The rise in a handful of huge technology companies was enough to push the entire stock market upwards in 2023, overcoming the negative impact from rising interest rates. The financial sector took a hit in early 2023 as several mid-size banks collapsed suddenly. The more economically sensitive parts of the market – small and midcap stocks – managed to produce gains, but far below those of the S&P 500. An additional hindrance to small and midcap stocks was the heavy weighting of financial stocks in those indices.

The American stock market performed better than its international counterparts, although European stocks have fared relatively well.

Emerging markets struggled. China, which comprises roughly 40% of the emerging market index, persisted with its zero-covid stance until a sudden reversal at year-end. That policy - along a government assault on its home-grown technology firms as well as a crackdown on property firms - took a toll on Chinese equities. Any signs of relief from these restrictive policies have been greeted with relief from investors, although the capricious nature of Chinese authorities continues to be a threat, as does the economic hostilities between the US and China. China’s attempts to present a welcoming attitude towards investment and dynamism have been thwarted by heavy-handed government actions.

REITs prices fell in 2022, as tightened financial conditions spooked investors. Rising interest rates have hurt commercial real estate values. Although this asset class continues to broaden and includes much more than the traditional office and apartment properties, the rise in work-from-home employment has had a drastic effect on office valuations and this appears to be a structural, rather than cyclical, change. Despite the negative headlines, REIT prices have stabilized and inched upwards in 2023, reducing the twelve-month loss to a few percent.

Natural resource prices rose and fell along with the economic outlook. When recession fears became prominent, oil prices fell. Energy stocks ended the twelve-month period with solid, unspectacular gains. Alternative energy stocks, although seemingly well-positioned for the long-term, endured a relatively poor period, wounded by lengthened paths to profitability, tightening financial conditions, and continued reliance on fossil fuels. Solar stocks have fared a bit better than other alternatives.

Overall, the effects of diversification from the traditional S&P 500 index were decidedly negative. Small and mid-cap stocks lagged, while international equities were dragged down by emerging markets.  Real estate had a relatively poor year. Gains in conventional energy stocks were dwarfed by the large-cap technology companies that dominate the S&P.

The Fixed Income Markets

The Fed raised interest rates dramatically as inflation reached levels not seen in decades. After a historically bad period in 2022, bond prices stabilized and have risen slightly in 2023. The moderation in inflation was cheered by bond investors. The twelve-month period saw the overall bond market post a small loss of -0.9%. Cash and similar investments were a safe haven, and by June the rate of return from money markets actually exceeded the rate of inflation.