Quarterly Commentary 4Q’22
Goodbye 2022. Welcome 2023
Markets delivered much-welcomed positive returns in the final quarter of 2022, with the US-based S&P 500 up 7.6% and the global MSCI ACWI index up 9.9%*. Bonds were also positive with the US Aggregate Bond Index increasing 1.9%*.
While the 4th quarter brought a welcome reversal from prior quarters, it was not enough to offset what was a rough year for both stock and bond investors. In retrospect, the story of 2022 in markets was straight forward: a combination of post-pandemic rising consumer demand and supply chain struggles, exacerbated by the war in Ukraine and soaring energy prices, led to ballooning inflation and a steep rise in interest rates around the world. The US Federal Reserve raised its Federal Funds rate a total of 7 times in 2022, pushing it up a steep 4 percentage points in just 9 months. Increasing rates put pressure on asset prices across the board and raised the specter of a potential recession. When all was said and done, the global MSCI ACWI finished 2022 down 18%, the S&P 500 was down 19%, the tech-heavy Nasdaq declined 33%, and the US Aggregate Bond Index was down 13%*. Bonds had an especially difficult year. Bonds usually act as a stabilizing force within portfolios, but that was not true in 2022 as the steep rise in interest rates led to a sell-off in the typically more stable bond markets. With both stocks and bonds down, many investors experienced some of the worst portfolio declines we’ve seen.
But here’s the thing: following 2022’s precipitous and painful rise in interest rates, we see markets being in a healthier position than they were 12 months ago. Interest rates needed to adjust, and a good chunk of that is now behind us. Of course, it’s still not clear how stubborn inflation will be – or if higher interest rates will push the economy into recession. So far we’ve seen some moderating corporate earnings projections and softening in housing prices as rates rise, but labor markets remain tight and consumer spending is still strong. There may be more interest rate increases ahead if inflation pressures continue. Conversely, we don’t expect a reversal of Fed policy (that is, decreasing rates) until there’s a very significant decline in economic activity – in other words, not any time soon.
In Figure 8 portfolios we’re staying focused on stocks poised to do well in the energy transition and those that have weathered previous inflationary environments with relative strength, e.g., companies with strong balance sheets, sustainable earnings, and promising innovations. The rise in interest rates has led to a contraction in stock valuations and we think some of that is overdone – we’re seeing opportunities with valuations that look attractive even in a higher rate environment. Bonds have rapidly become more attractive as rates have risen; they now offer significantly higher yields than 12 months ago. We remain focused on high credit quality, intermediate length bonds, and are finding many opportunities to finance sustainable projects while taking advantage of the changing interest rate environment. While there may still be some rough patches in markets ahead, our strong bent is that the worst of the pain is behind us; we’re forecasting healthier market returns ahead.
* Source for Stock Index Returns: Refinitiv Datastream; Source for Bond Index Returns: The Wall Street Journal
Our Crystal Ball
Whenever we make predictions about the markets, we do so with humility knowing that the unforeseen can derail even the most informed prognostications! That said, here are some other predictions for 2023:
Climate tops the agenda. With world leaders now coming to consensus in accepting the existential threat of a warming planet, we foresee a massive acceleration in the buildout of clean energy technologies and the investment opportunities that go with it. The Inflation Reduction Act, signed into law in August, supercharges all that and ushers in a new era for clean energy in the US. For 2023 we are most optimistic about US solar production, satellite-delivered asset-level emissions data, and breakthroughs in battery technology. We also expect the SEC to institute game-changing new rules requiring climate risk disclosures from publicly traded companies.
The clean energy transition will open new paths to racial economic justice. Big economic shifts bring opportunity, which historically has too often benefited primarily the wealthiest people and companies. Not this time! We see the movement for a just transition taking off in 2023, spurred in part by the Inflation Reduction Act’s $47 billion provision for environmental justice. While funding is focused on protecting vulnerable communities from negative climate-related impacts, we believe economically promising solutions will come from those very same frontline communities that have historically borne the brunt of environmental injustice. As an example, see Bloc Power.
Human Ingenuity will save us again and again. While we can’t rely on science and innovation to solve all the challenges facing humanity, we are bullish on human creativity! In 2023, we expect to see the same mRNA technology underlying the most effective Covid vaccines to begin trials for the treatment of malaria and tuberculosis. As previously mentioned, this year may alsobring battery breakthroughs; we see scientists on the cusp of battery innovations that will enable a more fully renewable energy grid.
Worker power persists. After decades of declines in labor union membership and clout, today’s hot labor market has sparked a resurgence of support for unions and the voices of workers. While we may see the labor market cool and we still may not see an increase in the federal minimum wage, workers have been empowered! Many have already gained significant wage increases – and the momentum behind the push for better pay and improved working conditions is not slowing down. In 2023, we expect a spotlight on paid sick leave as a benefit, increasing union membership, and more companies transitioning to cooperative worker-owned structures.
With that, we enter this new year feeling hopeful, energized, and motivated to continue our work and are excited to have you join in that journey.
You should always consult a financial, tax, or legal professional familiar with your unique circumstances before making any financial decisions. This material is intended for educational purposes only. Nothing in this material constitutes a solicitation for the sale or purchase of any securities. Any mentioned rates of return are historical or hypothetical in nature and are not a guarantee of future returns. Past performance does not guarantee future performance. Future returns may be lower or higher. Investments involve risk. Investment values will fluctuate with market conditions, and security positions, when sold, may be worth less or more than their original cost.