CAPITAL MARKETS REVIEW January 2023

Final Quarter – A Silver Lining During a Tough Year

The fourth quarter proved to be a silver lining when reflecting on returns during 2022, as most major asset classes rallied during the last quarter of the year. Going out on a positive note was certainly a relief for beleaguered investors. 2022 still went down as one most will wish to forget. While big-picture macroeconomic forces often play a key role in market performance, 2022 was a year where they were the dominant factor in returns. The key variable: stubbornly high inflation that led to interest rate increases by nearly all major central banks. Fueled by a red-hot economy, supply chain snarls spilling over from the pandemic, and a surge in oil and other commodity prices brought on by Russia’s attack on Ukraine, inflation stayed higher, for longer than most investors—and the Fed—had initially expected.

With rate increases continuing to dominate headlines during the fourth quarter, investors began to shift their opinion on how high rates might go. The rally in markets was widespread, as both stocks and bonds finished the quarter higher. International stocks performed the best as the dollar weakened against most other currencies, helping boost returns based in US Dollars. The winner for the year, commodities, posted another positive quarter, though returns were slightly subdued as investors have begun to worry about waning global demand in the year ahead. Finally, real estate had a positive quarter. This sector had been hard hit by rising interest rates, falling occupancy in offices, and generally elevated valuations across the various real estate sectors.

Relief Rally in Equities

Stock markets across the globe rallied during the fourth quarter as investor concerns over rising interest rates and inflation moderated. The US stock market (S&P 500) returned 7.6% in the fourth quarter, bringing the full-year return to -18.1%. The move higher was led by the energy sector, up 22.8% for the quarter and 65.7% for the full year, as years of capital discipline and rising prices led to record profits. Foreign stocks (MSCI ACWI ex. US) returned 14.3% and - 15.6%, respectively, as currency effects proved to be a tailwind.

It was a terrible 12 months for growth stocks, which had their worst calendar year in over a decade. Amid the carnage, value stocks showed clear signs of a leadership comeback. Prior to last year, the growth index had consistently outperformed the value index since 2008. In 2020 and 2021, high-flying tech giants drove big gains for growth stocks, leading to some of the widest performance gaps over value stocks on record. But these sky-high tech valuations took a blow from quickly rising interest rates, leading to the growth stock implosion. While tech stocks collapsed, value stocks remained relatively buoyant during the bear market, with some value stocks managing to carve out gains. Value stocks, as a group, are now ahead of growth stocks on a trailing one-, three-, and five-year basis.

Interest Rate Expectations Fall

Steep losses were suffered in nearly all areas of fixed income, driven by surging inflation and the Fed’s unprecedented interest-rate increases. The fourth quarter offered some relief, with most areas of the bond market posting positive three-month returns, but it wasn’t enough to reverse the abysmal performance seen in the rest of the year. The yield on the 10-year U.S. Treasury rose to 4.25% in October, its highest level since 2008, and ended the year at 3.8%, back to where it had started the quarter. With rates that were unchanged for the quarter, investors were able to collect the higher coupons offered by new bonds, generating low single-digit returns across most sectors.