Last year was a unique one, particularly for financial markets. We’ve heard time and time again that 2022’s market performance—or underperformance—was driven by the Federal Reserve and economic factors, mainly inflation. The roaring pace of consumer prices lit a fire under Fed officials, leading to the fastest increase in borrowing costs since the early 80s and the time of Paul Volcker—the Fed Chair who’s widely credited with ending the rampant inflation of the 1970s. Not so coincidentally, inflation and interest rates are two of the largest factors in valuing investment assets. Investors didn’t take the rate hikes, or the inflation prints, lightly.
US stocks, represented by the S&P 500 Index, slumped in the first part of 2022 before swaying between single and double-digit losses, ending the year down 18 percent. While it was an unpleasant experience for many, long-term investors have seen many ups and downs in stocks over the years. However, investors haven’t been forced to deal with the puzzle of both high inflation and high rates in several decades. In fact, coming out of the 2008 financial crisis, the Fed’s goal—which it had been unsuccessful in—was to actually raise inflation closer to its “optimal” two percent target. The typical market relationship of bonds moving opposite to stocks was thrown out the door. The Bloomberg US Universal Bond Index lost 13 percent last year. Unique is definitely a word for it. 2022 was the first calendar year that saw both stocks and bonds decline since the mid-70s, and it may be the first to suffer double-digit declines in both categories.
Looking forward, financial markets face some uncertainty this year. Forecasts are becoming more optimistic that the Fed has finally gained the upper hand on inflation, but the cost may also be high. Raising interest rates throttles economic growth and has historically led to recession. For now, economic forecasts seem to be for marginally positive growth in 2023—though, realistically, there is more risk to the downside.