Our Thoughts on fourth Quarter 2022
Matt Johnson, CFA® - Andy Nugent, CFA®
Market Recap, Portfolio Analysis, and Review
The S&P 500 rallied off its yearly lows which we saw in September. The quarter started off well with strong gains in both October and November, before ending the year with a thud in December. For the fourth quarter, the S&P 500 was up over 7%, but was down nearly 20% on the year.2022 was the worst performing year since the banking crisis of 2008. Even worse, the technology heavy NASDAQ was down 33% on the year, albeit only off 1% in the fourth quarter. The fed continued their battle against inflation by raising rates again in the fourth quarter and it might be working as the inflation rate is off its peak. 2022 was a tough year, but if the fed slows or stops raising interest rates and inflation continues to fall, we could see positive returns in the coming year. That all depends on earning of course. Earnings estimates are lower in many cases and that is already priced into the stocks. The next round of earnings could very well set the tone for 2023.
Inflation is measured by the Consumer Price Index (CPI) and Personal Consumption Expenditures (CPE). The CPI measures the average change in price of a basket of goods and services. The CPE is the CPI excluding food and energy components. Through November we continued to see a slowdown in inflation as it measured a bit above 7%. This is off the peak, but still very high when compared to historical norms and much higher than the Fed’s target of 2%. Although we think peak inflation is behind us, it will take quite a while to get down to the Fed’s goal.
We all feel the higher price of groceries. Airline tickets are no bargain. Gas prices remain elevated although off their high. It seems prices have become way too high in many areas. However, it seems like auto dealerships are offering incentives again, so maybe that is a sign of things to come.
The Fed continued raising rates in the 4th quarter. They raised rates twice in the quarter. 75 basis points in November followed by a 50 basis points increase in December. For the year, the Fed raise rates seven (7) different times totaling 4.5%. Keeping in mind the Fed Funds rate at the beginning of the year was almost zero, but seven rate hikes seem like a lot. We are encouraged to see that the last hike in December was 50 bps (the previous four were 75 basis points each). Hopefully, they are slowing down and will pause to give the economy time to digest these significant moves.
As these interest rates rise, mortgage rates also increase. Per Bankrate, the average 30-year fixed rate mortgage rose from 5.85% to 6.83% at quarter end. This makes for an interesting situation. Those who own homes already at low interest rates are not likely to sell and purchase a new home and take on a loan at a much higher rate. We expect the supply of home for sale to remain low, which should soften the drop in real estate prices.
Yields on Treasuries are increasing, with short-term treasuries yielding more than longer term treasuries. Six-month treasuries are yielding about 4.75%, with money market rates climbing to near 4%.
The rising interest rates have made purchasing bonds more attractive. We added to our bond position in our portfolios that hold fixed income. We are targeting short term maturities from 3 to 6 months. The plan is to hold them until maturity and roll them into additional treasuries which we think will be at the same yield or higher.
To truly achieve the stated yield for any new issue bond is to hold it to maturity. If an investor sells a bond before it matures in a rising interest rate environment, they will get a lower price on the sale of said bond. With the inverted yield curve, we are staying very short term with our purchases.
Nearly all sectors experienced positive performance apart from Consumer Discretionary and Communication Services in the quarter. For the year, Energy was the only sector boasting positive returns. As we can see from the chart above, most sectors are significantly off their 52 week lows. As American’s are feeling the pinch of high inflation, it makes sense that Consumer Discretionary is yet to recover. People are holding off from purchasing items they don’t necessarily need until they are more confident. As for trading activity, we added a little money to the market mostly in Industrials while topping off a few names whose prices were down.
Industrials – We added to our position in the Industrials by purchasing an Industrials ETF as well United Parcel Service. We feel that UPS was unduly punished with the economic slowdown, and while it may take some time, cash flows and earnings remain strong. Market sentiment will eventually change and as we invest for the long-term, we feel we purchased this at a significant discount to its true worth.
Energy –Energy continued to be the best performing sector both in the quarter and for the full year. After being up nearly 50% in 2021 and almost 60% in 2022, companies in this sector are not appealing from a valuation perspective as they are too expensive. They look to be riding peak earnings or the multiples are just too high to take an initial position here.
Information Technology – Technology market performed in the fourth quarter but was off almost 30% for the year. Many quality companies reside in this area, but with rising interest rates, the demand is expected to drop off, so the market sold off. Again, thinking long term, We look to average down in names whose valuation multiples look more reasonable than they did a year ago.
2022 reminds us of the Hank Williams Jr. lyric, “The interest is up and the stock markets down….“ However, the prior three years had such tremendous gains that a market pullback is not unexpected. As we look for companies to buy, it is a stock pickers market as not everything is cheap. It is with diligent analysis that we can uncover some opportunities that may be worth pursuing. Having said that, we believe we will not test the September lows in 2022. We think the market will be choppy until there is more clarity on the Fed increase rate policy and the effect that will have on inflation. Once the Fed slows down or stops the interest rate hikes, if earnings come in strong, we could see decent upside ahead. Once again, we thank you for your continued support in helping you to reach your financial goals. We thank you for your continued confidence allowing us to help reach your financial goals.
Matt Johnson, CFA® - Andy Nugent, CFA®
Sage Capital Advisors, LLC is a Securities and Exchange Registered Investment Advisor. Sage Capital Advisors is headquartered in Sioux Falls, South Dakota. Advisory services are only offered to clients or prospective clients where representatives of Sage Capital Advisors are properly licensed or exempt from licensure. This market commentary is solely for informational purposes and should not be construed as investment advice, it is only intended to provide education about the financial industry. Historical performance results for investment indices and/or categories have been provided for general comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of investment management fees, or the impact of taxes, all of which would have the effect of decreasing historical performance results. Indices are unmanaged and cannot be invested in directly. It should not be assumed that your account holdings correspond directly to any comparative indices. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered unless a client service agreement is in place.