Despite a strong rebound in the first two-thirds of the final quarter of 2022, during which most major asset classes and categories enjoyed positive performance, December saw a return to the same weakness that global asset allocators had endured throughout much of the first three quarters of 2022. Cooling inflationary data, moderating interest rates, a declining U.S. dollar (USD), and the potential for an incremental reduction in the pace of Federal Reserve (Fed) tightening all underpinned the rally across the financial markets during the quarter. However, concerns that the elevated inflationary backdrop may prove a persistent headwind weighed on performance in December, supported by evidence that the “stickiness” of the current inflationary regime may remain a concern. Global equity performance was predominantly negative in December. International developed stocks – as measured by the MSCI EAFE Index – materially outperformed U.S. equities for both the quarter and the year. This theme dominated the global equity performance tone of the fourth quarter. Emerging market equities also enjoyed a solid rally in the fourth quarter, outperforming domestic equities. Bond returns were positive in the fourth quarter, as increased interest rates were predominantly at the short end of the yield curve, and credit-sensitive sectors benefited from the risk rally. Performance across real assets was similarly positive for the quarter, although headwinds such as deteriorating global economic fundamentals and rising interest rates weighed on the asset category at the end of the year.
Signs emerged in the fourth quarter that the Fed’s tightening measures deployed throughout 2022 are beginning to alleviate multi-decade high inflation, which supported the growing narrative that a “pause” in the Fed’s tightening campaign may be on the horizon. Indeed, both headline and core measures of inflation moderated in both October and November, as headline consumer prices cooled to a 7.1% annual pace through November—versus a cyclical high of 9.1% in June—and core consumer price inflation declined to a 6.0% annual pace, slightly down from the cyclical high of 6.6% in September.
Key factors supporting the rebound across most major asset classes and categories in October and November were a potential peaking of inflation, which spooled to a 40-year high in 2022, and the related sentiment surrounding an incremental reduction in the pace of Fed tightening, with moderating interest rates and a cooling-off of the USD providing the necessary market conditions for a performance rebound.
While there is some evidence that the current inflationary episode may have run its course, it remains unclear whether the Fed’s job is complete. Despite progress in recent months toward restoring price stability, some measures that seek to approximate the “stickiness” of inflation continue to trend higher. Through November, for example, the Federal Reserve Bank of Atlanta’s Sticky core CPI data series advanced to a fresh cycle high of 6.5%, despite modest declines in the reported CPI rate since September. Notably, the 6.5% November print was the most elevated reading of this gauge since 1982.
A persistent complicating factor is the surprising resilience of the U.S. labor market, which ended 2022 with an unemployment rate of 3.5%, the lowest rate in more than 50 years. Moreover, the number of job openings, which stood just shy of 10.5 million through November, continues to surpass the availability of labor capital, with less than six million unemployed individuals remaining sidelined through year-end. Consequently, nominal wages have been increasing at an elevated pace but still below the rate of inflation, which adds to inflationary pressures as employers attempt to add to and maintain their labor force. Until this labor market imbalance approaches a state of equilibrium, the Fed may find it challenging to engineer a soft landing, resulting in further financial market volatility and economic hardship for a broad swath of the general populace.
To summarize, performance across the financial markets in December was decidedly negative, particularly among the rate-sensitive sectors of the marketplace, which suffered through one of the worst calendar years on record, as inflation angst and monetary tightening measures by the Fed negatively impacted performance. This recent trend may ultimately reverse, however, when the full effects of a broad economic slowdown become too difficult for global investors to ignore.
INDICES
The Alerian MLP Index is a composite of the 50 most prominent energy Master Limited Partnerships that provides investors with an unbiased, comprehensive benchmark for this emerging asset class.
Bloomberg Fixed Income Indices is an index family comprised of the Bloomberg US Aggregate Index, Government/Corporate Bond Index, Mortgage-Backed Securities Index, and Asset-Backed Securities Index, Municipal Index, High-Yield Index, Commodity Index and others designed to represent the broad fixed income markets and sectors. On August 24, 2016, Bloomberg acquired these long-standing assets from Barclays Bank PLC. and on August 24, 2021, they were rebranded as the Bloomberg Fixed Income Indices. See https://www.bloomberg.com/markets/rates-bonds/bloomberg-fixed-income-indices for more information..
The CBOE Volatility Index (VIX) is an up-to-the-minute market estimate of expected volatility that is calculated by using real-time S&P 500 Index option bid/ask quotes. The Index uses nearby and second nearby options with at least eight days left to expiration and then weights them to yield a constant, 30-day measure of the expected volatility of the S&P 500 Index.
FTSE Real Estate Indices (NAREIT Index and EPRA/NAREIT Index) includes only those companies that meet minimum size, liquidity and free float criteria as set forth by FTSE and is meant as a broad representation of publicly traded real estate securities. Relevant real estate activities are defined as the ownership, disposure, and development of income-producing real estate. See https://www.ftserussell.com/index/category/real-estate for more information.
HFRI Monthly Indices (HFRI) are equally weighted performance indexes, compiled by Hedge Fund Research Inc. (HFX), and are used by numerous hedge fund managers as a benchmark for their own hedge funds. The HFRI are broken down into 37 different categories by strategy, including the HFRI Fund Weighted Composite, which accounts for over 2,000 funds listed on the internal HFR Database. The HFRI Fund of Funds Composite Index is an equal weighted, net of fee, index composed of approximately 800 fund- of- funds which report to HFR. See www.hedgefundresearch.com for more information on index construction.
J.P. Morgan’s Global Index Research group produces proprietary index products that track emerging markets, government debt, and corporate debt asset classes. Some of these indices include the JPMorgan Emerging Market Bond Plus Index, JPMorgan Emerging Market Local Plus Index, JPMorgan Global Bond Non-U.S. Index and JPMorgan Global Bond Non-U.S. Index. See www.jpmorgan.com for more information.
Merrill Lynch high yield indices measure the performance of securities that pay interest in cash and have a credit rating of below investment grade. Merrill Lynch uses a composite of Fitch Ratings, Moody’s and Standard and Poor’s credit ratings in selecting bonds for these indices. These ratings measure the risk that the bond issuer will fail to pay interest or to repay principal in full. See www.ml.com for more information.
Morgan Stanley Capital International – MSCI is a series of indices constructed by Morgan Stanley to help institutional investors benchmark their returns. There are a wide range of indices created by Morgan Stanley covering a multitude of developed and emerging economies and economic sectors. See www.morganstanley.com for more information.
The FTSE Nareit All Equity REITs Index is a free-float adjusted, market capitalization-weighted index of U.S. equity REITs.
Russell Investments rank U.S. common stocks from largest to smallest market capitalization at each annual reconstitution period (May 31). The primary Russell Indices are defined as follows: 1) the top 3,000 stocks become the Russell 3000 Index, 2) the largest 1,000 stocks become the Russell 1000 Index, 3) the smallest 800 stocks in the Russell 1000 Index become the Russell Midcap index, 4) the next 2,000 stocks become the Russell 2000 Index, 5) the smallest 1,000 in the Russell 2000 Index plus the next smallest 1,000 comprise the Russell Microcap Index, and 6) U.S. Equity REITs comprise the FTSE Nareit All Equity REIT Index. See www.russell.com for more information.
S&P 500 Index consists of 500 stocks chosen for market size, liquidity and industry group representation, among other factors by the S&P Index Committee, which is a team of analysts and economists at Standard and Poor’s. The S&P 500 is a market-value weighted index, which means each stock’s weight in the index is proportionate to its market value and is designed to be a leading indicator of U.S. equities, and meant to reflect the risk/return characteristics of the large cap universe. See www.standardandpoors.com for more information.
Information on any indices mentioned can be obtained either through your advisor or by written request to information@feg.com.
DISCLOSURES
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All data is as of December 31, 2022 unless otherwise noted.