Year-End Review

I remember thinking to myself in late 2019 that the new year would bring not only a new decade but a decade with a definitive name.  Unlike the previous two decades of the 2000s and the 2010s, our new decade would have a real name; the 20s.  Even better, the last time we had the 20s, times were so good they were called the roaring 20s.  Hopefully, history would repeat itself.  Instead, the only history that repeated itself was a global pandemic like we hadn’t seen since 1918.

As we concluded the third year of our maturing decade, the story has been and continues to be the pandemic, our response to it, and the consequences of those reactions. Unrelieved chaos continued in 2022.

The central drama of the year—and, it seems likely, of the coming year—was the Federal Reserve’s belated but very aggressive efforts to bring inflation under control.

After multiplying seven times in the nearly 13 years between the trough of the Global Financial Crisis (March 9, 2009) and this past January 3, the U.S. equity market sold off sharply; at its most recent trough in October, the S&P 500 was down 27%. (Bond prices also swooned in response to sharply higher interest rates.)

It seems to me a little ironic that, after the serial nightmares through which it’s suffered since the onset of the pandemic early in 2020, the mainstream equity market managed to close out 2022 somewhat higher than it was at the end of 2019 (3,840 versus 3,231, a gain of 18.85% in total or 5.9% annualized). Not great, but not at all bad for three years that included two bear markets and which our entire economic, financial, political, and geopolitical world blew up.

If anything, this tends to validate our core investment strategy over these three years, which—simply stated—has been: stand fast, tune out the noise and continue to work your long-term plan. Needless to say, that continues to be my recommendation, and in the strongest possible terms.

The burning question of the hour seems to be whether and to what extent the Fed, in its inflation-fighting zeal, might tip the economy into recession at some point—if it hasn't already done so. Over the coming year, the way this plays out may determine the near-term trend of equity prices. My position continues to be that this outcome is simply unknowable and that one cannot make rational investment policy out of an unknowable.  That said, I continue to believe strongly that whatever it takes to put out the inflationary fire will be well worth it. Inflation is a cancer that affects everyone in our society; if recession proves to be the painful chemotherapy required to destroy that cancer, then so be it.

I encourage you to peruse the chart below.  It shows history of our last nine recessions, including their length and the paths that stocks and the unemployment rate took during before, during and after these recessions.

Although these episodes are each unique, you may see some trends.  One is that stocks tend to be a leading indicator, and unemployment is a lagging indicator.  Stocks tend to go down before a recession and start to recover during the recession.  At a time like this, I am reminded of the words of Jeremy Grantham, a well-known investor who said shortly before the March 2009 market bottom, “Be aware that the market does not turn when it sees the light at the end of the tunnel.  It turns when all looks black, but just a shade less black than the day before.”