Articles

It is important to remain focused on the fundamentals of investing, especially when times are scary. Fundamental investing concepts like diversification and rebalancing are most important when investors feel unsettled. 2022 was a bad year for most markets. That, combined with all the frightening news coming out of China, Ukraine, and other hot spots, caused a lot of investors to give up on international stocks for the safety of the U.S. What most people don’t realize is that diversified investors have been rewarded handsomely for staying in international stocks. Both developed and emerging markets have significantly outperformed the U.S. over the last 3 to 6 months. We’ve heard it a thousand times, but it bears repeating: the best returns often come very shortly after the worst. By remaining committed to diversification, we’re positioned to capture strong returns when they come.

It’s also important to periodically rebalance investment portfolios. Ever since the Great Financial Crisis back in 2008/9, the potential return to bonds has been low. A little over a year ago most bonds were barely paying 2% and some offered a negative yield. This was followed last year by the worst bond market in a century with prices falling as much as 15%. With this pain has come notable opportunity. Corporate bond yields are back above 5%, providing investors with much more attractive potential returns. While rebalancing from stocks to bonds has been an unattractive proposition for many years, the current environment provides an opportunity for many investors to consider rebalancing into a much more attractive bond market.

We have long said discipline is the key to long-term investing success. The COVID-induced economic and market volatility we have seen over the past several years teaches us that, while the cause of volatility varies, many of the successful strategies we employ as thoughtful investors will remain tried and true. It is rarely unwise to focus on the fundamentals, especially during periods of instability.

Monthly Market Summary

• International stocks outperformed for a third consecutive month as the U.S. dollar weakened. Looking out a little longer, the MSCI EAFE Index of developed market stocks returned +22.1%, in line with the MSCI Emerging Market Index’s +22.7% return over the last 3 months compared to 5.7% from the S&P.
• Corporate investment grade bonds generated a +5.2% total return, outperforming corporate high yield bonds’ +3.7% total return. The positive bond returns occurred as Treasury yields declined across most of the yield curve.
• The S&P 500 Index returned +6.3% in January, underperforming the Russell 2000 Index’s +9.8% return. 2022’s underperforming sectors were the top performers in January, while defensive sectors posted negative returns.

Fourth Quarter GDP Growth Slows but Remains Positive

The U.S. economy grew at a +2.9% annual rate in the fourth quarter of 2022, down from the third quarter’s +3.2% annual rate. The growth was largely driven by a resilient consumer, inventory restocking, and increased government spending, while businesses cut back their spending on equipment and the housing market remained weak. While GDP growth was positive for a second consecutive quarter, the pace of economic growth slowed as the year ended. The U.S. economy grew +1% year-over-year compared to the same quarter a year ago, a slowdown from the +5.7% year-over-year growth rate recorded in the fourth quarter of 2021.

The slowdown signals a return to a more normal pace of growth after 2021’s strong growth. Looking ahead to 2023, the U.S. economy is forecasted to slow as the cumulative effect of higher interest rates takes hold. Economists are concerned the Federal Reserve's efforts to curb inflation could trigger further spending cutbacks and job losses and tip the U.S. into a recession.

Financial Conditions Loosen in Anticipation of 2023 Interest Rate Cuts

Financial conditions, which refer to the ease and cost of obtaining capital, loosened in January. The catalyst was the market’s anticipation of possible interest rate cuts in late 2023 due to a slowdown in economic activity. Treasury yields declined, corporate bond spreads tightened, and mortgage rates declined another -0.40%. Lower stock and bond market volatility, which reduces the level of perceived risk and encourages more investment activity, added to the loosening of financial conditions.

The Federal Reserve has expressed concern about the potential for loose financial conditions to undercut its efforts to bring inflation down. When financial conditions are loose, people are more willing to take risks and borrow money, which can lead to higher spending and demand for goods and services. This increased demand could drive up prices, keeping inflation elevated and forcing the Federal Reserve to tighten further. Policymakers will keep a close eye on financial conditions as 2023 progresses.