In some ways, we seem to be ending the year in the markets as we began it — except locations have changed.
We’ve got a major central bank that turned more hawkish. This time it’s not just the Fed, but the ECB. They are increasing their rates at a faster clip now after being slow to move for most of the year. Plus, the Bank of Japan (BOJ) made a surprise move with their rates, increasing the allowed range of their 10- year bond from 0-0.25% to 0-0.50%. They are saying it's just to manage their QE program better, but I personally think they are on the eventual same path as we’ve seen around the world with interest rates.
We’ve got a huge surge of Covid cases — but this time in China. China has reduced restrictions and, as a result, cases are surging. It was probably inevitable, as unless they kept quarantines in place, the virus would spread.
The US stock market is down (again). As measured by the S&P 500, it is down about -6% this month so far, while in January 2022, it was down about -5%. No Santa Claus rally for us yet (see number one).
We shared our outlook for 2023 last week, and it included related expectations like:
Moderating US interest rates and inflation: We expect the 10-year treasury yield to move between 3-4% in the coming year, which led us to believe bonds could go back to doing what they have done in prior economic slow downs.
Which also led us to conclude:
US dollar to soften further, since the difference in interest rates from one country to the next often has an impact on the relative value of currencies.
Here’s a screenshot of the US Dollar Index for the last five years:
What does this mean for an investor? While it almost always depends on you, here are some considerations:
Review your portfolio. What kinds of investments do you hold? Are there any that could do well in an environment where interest rates, while higher than the last 10 years, are potentially no longer rising dramatically? One example is to look at solid dividend growers.
If you want to add some stability to your portfolio, consider bonds. For example, a short-term bond investment, or even a medium-term one that stays high quality, can offer fewer swings than stocks while providing income. That being said, with the Fed raising interest rates, cash can offer better yields, too.
Consider emerging market stocks. With China reducing their restrictions and the dollar potentially not as strong, it could be a better year for emerging markets, of which China makes up about ⅓. The reason why the dollar matters — as much as the view of the region — is that if the emerging stock market rises, but the dollar appreciates, your returns are negatively impacted. So it's important to understand both aspects. Of course, investing here means taking on more relative risk, so be sure it’s for you.
So while this year may be ending on a not great note, it is ending. And next year, I do believe there are things to look forward to. If you can stick with investing with a long time horizon, in a portfolio with the right mix for you, and even add to it, you should increase the odds of growing the value over time.
After all, one of my favorite data points shows that historically, if you missed the 10 best days out of the last 20 years (that's over 5,000 days) in the S&P 500 through October 2022, your return would have been about 50% less than if you had stayed invested over the whole period. The past is no guarantee of the future, but it can be helpful to know.
We’ll be skipping next week to recuperate after quite a year. A very happy holiday to all — see you in 2023!
First chart: Board of Governors of the Federal Reserve System (US), Nominal Broad U.S. Dollar Index [DTWEXBGS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/DTWEXBGS, December 19, 2022.
Second chart: Robinhood Financial