It was an up-and-down year for markets—in the end, one with more down than up. The world gave financial markets a lot to process. The coronavirus pandemic eased but remained a global concern, as did the supply-chain issues that accompanied its arrival. Inflation in Canada reached its highest levels since 1983 and the Bank of Canada pursued a series of interest rate increases to combat rising prices. Russia’s invasion of Ukraine in February brought uncertainty about political stability and energy prices, among other worries. Against this backdrop, equity and bond markets fell for the year, despite several rallies.
Inflation was front and center all year long. Canada experienced price increases above 8% year over year in June of 2022. 6% over the long-term target of 2%. While the rate of price increases declined to 6.3% in December, its slow retreat from multidecade highs could keep it a concern for central banks well into 2023. Supply-chain issues related to the pandemic and Russia’s war in Ukraine also eased, and food and fuel costs declined.
The S&P 500 Index1 fell to a two-year low in September; at one point, the index had given back 50% of its post-pandemic rally. After the sharp drop in the first half of the year, led by technology stocks, the stock market rebounded somewhat. That came as the political situation became clearer and with investors pricing in prospects of smaller rate hikes going forward as inflation cooled. Despite the rally, the S&P 500 fell 18.1% for the year, its worst annual return since the financial crisis in 2008. Likewise, global stock markets ended with their largest declines since the financial crisis. Global equities, as measured by the MSCI All Country World Index2, fell 18.4% (see Exhibit 1).
Late Rebound Not Enough for Markets
Silver Linings for Battered Bonds
Fixed income has historically acted as a safe haven for investors, rising in years when equities have done poorly. However, this was not the case in 2022 as rising rates hampered the return of bond portfolios. The tandem decline for equities and fixed income was relatively rare. Higher interest rates can bring short-term pain as bond prices fall, but they can be beneficial in the long term and present new opportunities for fixed income investors. Some investors may be hesitant to take advantage of higher yields, perhaps because of concerns about the potential for even higher yields to come. But higher yields may lead to higher expected returns. Similarly, investors who have seen equity prices fall may be tempted to sell. But lower stock prices can be indicative of higher expected returns3.
A Reset for Crypto and FAANG Stocks
If the market decline of 2022 taught investors anything, it’s that what goes up might also come down. Some of the most hyped investments of the past two years did just that. Cryptocurrencies4 and FAANG stocks5 were all hit hard, with bitcoin falling below $17,000 USD, about 75% lower than its high of nearly $68,000 in November 20216. As investors have learned by now, cryptocurrencies can be extremely volatile. From a distance, bitcoin might appear to have enjoyed a steady climb through much of its existence. There were, however, major slumps: On three occasions since 2017, bitcoin has fallen by more than 50%, including the decline that extended into 2022.
The FAANGs also saw notable declines in 2022 (see Exhibit 2). The group of tech stocks lost a combined $3.2 trillion USD in market value—one might say the market was de- FAANGed. Facebook parent Meta Platforms, Amazon, Apple, Netflix, and Google parent Alphabet all lagged the broad US market, with Facebook and Netflix suffering particularly sharp losses. The group collectively underperformed the Russell 3000 Index by more than 2%. The slump came on the heels of a stellar decade— the FAANGs returned 28% per year from 2012 to 2021.
Tech Giants De-FAANGed
That reversal is a reminder that investors should be cautious about assuming past returns will continue. Even if a company with a track record of strong stock returns remains broadly successful, that may not translate to spectacular future returns. Excellence may now be what investors are counting on and not the basis for above-market returns. This point is borne out by looking back at stocks as they grew to become among the top 10 largest by market cap. On average, their performance lagged the performance of the broader market within a few years of entering the top 10.
Taking A Balanced View Of The 60/40 Portfolio
With both fixed income and equities declining on the year, the traditional 60% stock/40% bond portfolio had a hard time offering much support in either asset category, leading some to question the utility of this approach. Although 2022 was the worst year in history for many bond indices, the performance of the 60/40 portfolio7 didn’t crack the top five peak-to-trough drawdowns in close to a century’s worth of data and the portfolio saw some recovery late in the year, ending down 7.6% for 2022.
During rocky markets, it is especially important for investors to focus not solely on where returns have been but also on where they could be going. Looking at the performance of a 60/40 portfolio following a decline of 10% or more since 1926, returns on average have been strong in the subsequent one-, three-, and five-year periods (see Exhibit 3).
A Case for Optimism
Sticking With A Plan
We are long-term, goal-focused, plan-driven investors. We believe that lifetime investment success comes from acting continuously on our plan. Likewise, we believe substandard returns, and even lifetime investment failure, come from reacting to current events. The unforeseen and indeed unforeseeable economic, market, political and geopolitical chaos of the three years since the onset of the pandemic demonstrates conclusively that the economy can never be consistently forecast nor the market consistently timed. Therefore we believe that the most reliable way to capture the full return of capital markets is to ride out their frequent but historically always temporary declines. These will continue to be the bedrock convictions that inform our investment policy, as we pursue your most important financial goals together.
If you have any questions or wish to discuss your portfolio, we would be happy to schedule a meeting with you.
Danielson Group Wealth Management
Assante Capital Management Ltd.
1 S&P data © 2023 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved.
2 MSCI data 2023, all rights reserved.
3 Eugene Fama and Kenneth French, “The Cross-Section of Expected Stock Returns,” Journal of Finance 47 (1992): 427-65.
4 As of the date of this material, Dimensional does not offer investment in cryptocurrency. This material is not to be construed as investment advice or a recommendation to buy or sell any security or currency.
5 The FAANG stocks are Facebook (Meta Platforms), Amazon, Apple, Netflix, and Google (Alphabet).
6 Source: Bloomberg and Refinitiv.
7 The 60/40 portfolio consists of the S&P 500 Index (60%) and five-year US Treasury notes (40%).
All graphs shown above are from the Dimensional Returns web. This material is provided for general information and is subject to change without notice. Every effort has been made to compile this material from reliable sources however no warranty can be made as to its accuracy or completeness. Before acting on any of the above, please make sure to see a professional advisor for individual financial advice based on your personal circumstances.