Greenwood Gearhart is pleased to provide you the Fourth Quarter 2022 Market Commentary.
We wanted to recognize it was a difficult year for portfolios, with both equity and bond markets down on the year. This is an unusual circumstance but occurred because of a confluence of multiple interrelated factors including persistent inflation, an unwind of pandemic-era monetary policy, and the war in Ukraine. While our portfolios were not immune from this dynamic, we are pleased that Greenwood Gearhart portfolios performed as intended.
Within equities, our balanced approach and preference for high quality companies offered some downside protection in 2022, and within fixed income, a heavy skew towards short-term bonds with less interest-rate risk drove material outperformance versus the broader bond market. As we begin a new year, valuations are much more attractive in both equities and fixed income, creating the conditions for attractive upside in portfolios should the economy follow the path that is currently anticipated by markets.
Already, since we last reported to you, the financial markets stabilized from the October lows, with equities rallying approximately +10% and bonds moving higher as well due to a decline in interest rates. This move has been largely driven by economic data which suggests the Fed is starting to get a handle on inflation, which in turn has increased the market’s assessed chances of achieving a ‘soft landing’ in the economy. We offer the following thoughts on the market and economy as we start the new year.
- Markets are suggesting that the worst may be over in terms of rising interest rates. While the Fed will continue hiking the short-term rate until inflation reaches an acceptable level, various economic indicators are now providing concrete evidence that Fed policies are slowing the economy as intended
- In addition to commodity prices, bond yields, and consumer surveys which were already showing a slowdown in the third quarter, manufacturing and services PMIs, as well as wage inflation, have significantly moderated in the latest reports, further amplifying the market’s conviction that inflation has peaked
- In particular, the slowdown in wage gains has caused some optimism, as wage pressure is a key input into other types of inflation and is thus a metric the Fed is watching especially closely. As a result, markets are starting to anticipate a pause in interest rate increases later this year, with cuts potentially coming after that
- While this has been welcomed by the market as it reduces the chances of even higher interest rates, it does put more pressure on the Fed to not go “too far” and actually tip the economy into a deeper recession than maybe anticipated
- This represents a very delicate balancing act for the Fed, which is why markets are so closely watching key data and looking for subtle signs of an imminent change in Fed policy. Presently, markets are expecting a mild recession, placing more confidence in the Fed’s ability to manage this than it was just a few months ago.
- A key reason for this is the continued resilience of the labor market. While wage pressure is moderating, the economy is still adding jobs at a rate of over 200,000 per month, with an unemployment rate still at a very low 3.5%. And while layoffs have increased, it has so far been limited mainly to technology and financial companies which have been the most impacted by slowing growth
- Should the jobs picture remain resilient, the decline in consumer spending and thus corporate earnings may not be as bad as feared. Given the significant re-rating in stock valuations, this could suggest that the current environment remains a good buying opportunity for the patient investor. And even in the scenario where a greater pullback occurs, markets are already back at their long-term averages suggesting markets are reasonably priced
- Because markets typically bottom before the economy, it pays to remain invested when bearishness and uncertainty remain high. While it’s possible the market has gotten ahead of itself, forward-returns on a multi-year horizon have been pretty good historically from this point into a correction
While this backdrop remains uncertain, Greenwood Gearhart takes comfort in the high-quality skew of our portfolio companies: strong balance sheets, cash generative, high market share, competitive advantages, and low leverage. These companies are leaders in their sectors and among the best run companies in world. As a result, your portfolio is well equipped to not only weather the current volatility, but also participate strongly in the recovery as the economy normalizes. Already this year portfolios are performing better than the overall market, due in large part to recent acquisitions of high-quality stocks that were previously out of reach. So through this volatility, we are upgrading the quality of our portfolio as well as sowing the seeds for future performance.
We remain available at any time to review your investments and discuss your portfolio in-depth, either in-person or virtually. If you would like to take us up on this offer, please don’t hesitate to contact us to schedule. We appreciate you watching, and Happy New Year.