Looking Back and Moving Forward
The market has continued its positive trend to start the new year. While it feels like we have some semblance of stability in the market, they are far from over the hump when it comes to volatility. There are still many variables at play, namely the Federal Reserve’s decisions when it comes to interest rates.
The big spike in inflation has already happened, and the CPI numbers are beginning to trend in the right direction. We will continue to see inflation, but the recent Fed rate raise of .25% is a good indication that rate hikes are slowing down. This was the smallest rate hike since they began raising rates last March. We saw corporate earnings slightly miss the mark in some sectors, which is to be expected in an inflationary environment.
Looking Back on 2022
Almost anything would be better than what investors had to go through in 2022. By almost any standard, the markets had a horrible year. What made 2022 particularly bad is that both the stock market and the bond market had an awful year. Generally, we look at these different asset classes as hedges against each other, but 2022 was a major exception.
The stock market measured by the S&P 500, which is the largest 500 companies in the US, was down -19.44%.
We are proud to say that the portfolios that we manage were down substantially less. Our focus on quality, and particularly dividend-paying stocks, protected us on the downside and most portfolios had less than 50% of the market’s volatility. Our accounts that had heavy bond exposure also outperformed the market.
The Road Ahead
Looking in the rearview mirror is one thing, however, looking forward we have a completely different road ahead of us in 2023. In 2022 we dealt with rising interest rates and how to protect portfolios from the risk of declining values associated with these rates. In 2023 rates are now substantially higher. Thus, money market fund rates and CD rates are over 4%.
The temptation is to enjoy these risk-free rates and move bond money into these shorter maturities. Although utilizing money market funds for some of our money makes sense, the pitfall is that these rates are short-lived. As the economy slows down and the predicted recession comes about, the Federal Reserve will begin to lower rates. It is anticipated this change in Fed policy will take place this year. These attractive 4% money market rates will return to the levels we have seen in the past.
For investors that maintain large cash balances, this is an opportunity to benefit from these high money market returns. Charles Schwab’s money market fund is currently 4.5%.
With every change in the market, new opportunities present themselves. We have started to move money out on the time horizon to 5–7-year bonds. These bonds are not only trading at discounts, but they have yields in the 5-6% range. If rates do begin to drop, not only will the bond pay an attractive interest rate, but the discount would close, and the bond would also appreciate in price.
As stated earlier, the stock market has earnings and economic risk to deal with. Each sector of the market has different challenges. Some industries are faring better than others. This is always the case but these last few years we have come to think of the markets as only growth stocks. Value stocks performed much better in 2022 than growth, and we believe that trend will continue.
There is much less speculation in the markets and much more focus on earnings. Eventually, these markets will steady themselves and the growth stocks will have their time in the sun again, but not until the economy stabilizes itself. This bodes well for our philosophy of focusing on dividend-paying stocks. As always, patience pays off, and it’s nice to get paid to be patient.