Weekly Market Update December 30, 2022, Dow Jones Industrial 33,147.25 -.17%, S&P 500 3,839.50 -.14%,
Nasdaq Composite 10,446.48 -.30%, US Ten Year 3.879%, West Texas Intermediate $80.41
Does it need to be said that the year about to close has been a very bad year for stocks? Using the Standard & Poor’s 500 benchmark of large capitalization common stocks, 2022’s return of minus 20.07% is easily the worst performance since the negative 38.49% of 2008 during the depth of the financial crisis. Of the eleven sectors in the index, only Energy had a positive return for the year, an astounding plus 57.8%. The worst performing sectors were Technology, with a minus return of 28.8%, Consumer Discretionary, negative 37.4%, and Communications Services, down over 40%. High and increasing interest rates slashed the present value of future earnings, and investors eschewed the high growth, high price-to-earnings stocks that inhabit those sectors. They sought out safety in cash, short-term bonds and stocks paying stable dividends in Consumer Staples and Health Care, both of which were just barely in negative territory. Higher interest rates also squashed the value of bonds, whose prices move inversely to interest rates. The S&P Aggregate Bond Index returned a minus 11.89% after interest.
What does 2023 look like? The immediate future is staring at continued Fed tightening of monetary conditions, raising the Fed Funds rate and unwinding their balance sheet of government debt, to fight the inflation borne of the government’s reckless spending over the past two years. Adding to that gloomy outlook is fear of a recession. According to a recent survey of economists by The Wall Street Journal, there is a 63% chance of a recession in the next 12 months. Few observers are confident the Fed can engineer the much hoped for but elusive “Soft Landing.”
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From the table above we can get a glimpse of the relationship between inflation, as measured by the Consumer Price Index, and twelve-month forward price-earnings ratios. The November CPI reading was 7.1%, and that corresponds to an average P/E of 11.8. From Yardeni Research we learn that 2023 S&P 500 consensus earnings are $229.78. At today’s index of 3,825, stocks are trading at 16.6 times earnings. That would correspond to inflation declining to the 2 to 4% range. If Fed action to reach that level is done too quickly it will devastate the economy. Too slowly and inflation will linger, further depressing the value of company earnings.
Until we witness some solid indications of improvements in the inflation outlook and moderating of interest rate increases (the central bank’s “pivot”), cautious investing will be in order. That means cash and money market funds, government, agency and investment grade corporate debt, and stocks of companies that sell the necessities of life and have safe dividends. But the market will eventually return to bullish ways, and when it does it will be with a vengeance. Having funds in highly liquid cash and short-term investments will empower investors to reenter the ring when that happens.
We at M&R Capital Management Wish You a Prosperous 2023.