Year in Review – Twelve Months Ended 03/31/2023
As the pandemic gradually faded, policymakers and investors were left to confront the economic impacts of the global tragedy. In some cases, the governmental efforts to combat the pandemic worked all too well. Demand exceeded supply for numerous commodities, goods, and labor, leading to an inflationary surge that rattled the Federal Reserve as well as markets. Russia’s assault on Ukraine placed further pressure on prices as well as depressing consumer confidence, although the more dire economic forecasts did not come to pass. Investors could be forgiven for feeling confused as concerns oscillated between runaway inflation and an economic downturn. Eventually, signs of diminishing inflation helped bonds and stocks partially recover and lessen the magnitude of the declines.
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. A major surprise was the surge in demand for goods that caught manufacturers and suppliers off-guard. The Russian assault on Ukraine then had a further impact on prices of oil, food, and other crucial commodities. Inflation spurted higher, spreading to include services as well as goods. The Federal Reserve began raising rates at a very rapid pace. Commodity price pressures eased during the third 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.
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 alleviated some of the anguish. Rising interest rates pressured stocks, and few sectors were left unscathed. The exception was the conventional energy sector, which experienced gains. 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 – fared a bit worse than the S&P 500.
The American stock market performed slightly worse than its international counterparts, as Europe showed surprising resilience.
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.
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.
The demand for several commodities took suppliers by surprise and pushed prices higher. Oil stocks benefited from a favorable supply/demand situation. Additionally, geopolitical developments are restricting the supply of fossil fuels at a period when alternative energy is not yet able to fill the void. Alternative energy stocks, although seemingly well-positioned for the long-term, endured a 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 mixed to slightly negative. Small and mid-cap stocks lagged, while international equities provided a bit of assistance. Real estate had a poor year. Gains in conventional energy stocks were a lonely bright spot on the investment landscape.
The Fixed Income Markets
Interest rates rose dramatically as inflation reached levels not seen in decades. Bond prices move inversely to interest rates, and thus fell. The overall bond market experienced a severe loss of -4.8%, although diminished inflation in early 2023 has helped bond prices recover. Shorter-term inflation-protected Treasuries held up relatively well in this treacherous environment. International bonds also fared poorly, with the rising dollar providing a headwind. Cash and similar investments were a safe haven, even as yields remained low when compared with the rate of inflation.