Could 2022 have been worse? For stocks, definitely, yes. The S&P 500 U.S. stock index fell by more than 18%, which was only half as bad as the 36% drop it experienced in 2008, in the midst of the mortgage crisis and the resulting ‘Great Recession’. Nevertheless, last year’s decline was substantial enough to qualify as the fourth worst in the index’s history. For the bond market though, 2022 turned out to be absolutely the worst year ever for most indices. That was certainly true for the U.S. Aggregate Bond Index, whose double-digit decline surpassed a 9% drop way back in 1980.
Things actually looked even more miserable for stocks and bonds heading into the final three months of 2022. Thankfully, both of those markets actually recovered a bit after September, with traders perhaps anticipating an end to the Federal Reserve’s epic string of interest rate increases. As a result, the bond index rose almost 2% and the stock index rose 7.5%. Without that bounce, both indices would have ended the year at a low point, where bonds were down around 15% and stocks down around 25%. That momentum from the fourth quarter has, for now, carried over into the new year. Stocks and bonds are both off to a great start in 2023 and it would be nice to think we are out of the woods now. However, history may indicate otherwise.
Unfortunately, many economic indicators are still signaling a recession. That doesn’t bode particularly well for stock prices in the short term, as a recession would probably see stocks retest their September lows, and very likely undercut those lows to some extent. Just how much would depend on how deep the recession becomes. Barring some new economic threat, most economists are anticipating only a mild recession; nothing like 2008, where the banking system required massive government intervention to keep it viable. Although, like then, the housing market is currently in decline, consumers are less leveraged than they were going into 2008, debt-service as a percentage of income is much lower, lenders have been more conservative in their underwriting, and banks have three times the capital ratios they had back then.
Also, keep in mind that past performance never guarantees future results, especially when it comes to investments or the economy. The yield curve has proven an extremely reliable indicator, but it is not infallible and a recession is not a certainty. That makes it very difficult to try to trade around it, were one inclined to do so. Add to that the fact that stock market declines, especially those occurring in the ‘capitulation’ phase of a downturn, can be very abrupt, and the subsequent recoveries just as sharp. According to JP Morgan, the average return of the S&P 500 in the 12 months following a recession low is 24.9%. Recall that in the first 3 months of 2009, near the tail end of the Great Recession, the S&P 500 declined by 22%, only to rise 29% by the end of that year.
That said, any comparison to 2009 may not be particularly apt now. Back then (and again in 2020), Congress and Central Banks took extreme measures in a rush to rescue the economy from financial contagion. Today, Congress is split by party and arguably more polarized, which might make it less likely to take similar action. At the same time, the Federal Reserve may be reluctant to slash interest rates like they have in previous downturns for fear of reigniting inflation and erasing all of the progress from the past year. As a result, this recovery could be slower than the last few.
In the meantime, inflation does seem to be waning. The Consumer Price Index is still running at an uncomfortably-high 6.5% rate year-over-year, yet that is down from 9.1% in June. For the past 6 months, annualized CPI is only 3.7%, and over the past 3 months, annualized CPI is just 1.21%, with prices actually declining in December. Of course that trend could reverse itself, but if it remains in place, the Federal Reserve may be able to relax monetary policy sooner than anticipated. While it seems unlikely that we will go back to the days of 2% mortgages and 0% car loans (nor should we probably), the bond markets at least ought to perform much better with higher, more stable interest rates. And maybe the folks bidding stock prices back up are correct and we somehow manage to avoid a recession too. We shall see.
The information above represents the opinion of financial advisor Travis Rus, and is not necessarily that of RJFS or Raymond James. It is not a complete summary of all available data necessary for making an investment decision and does not constitute a recommendation, nor is it a complete description of the securities, markets, or developments referred to herein. Opinions are subject to change without notice. Information has been obtained from sources considered reliable, but we cannot guarantee that it is accurate or complete. Investing involves risk and you may incur a profit or loss.
The S&P 500 Index is an unmanaged index of 500 widely held stocks that’s generally considered representative of the U.S. stock market. The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. Inclusion of these indexes is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary and past performance does not guarantee future results.
