December 2022
US Economy: Data cornucopia mixed.
Unemployment remains low (near 3.7%) amid 10.7 million job openings, while retail sales (+1.3%) and consumer confidence (100.2) surpassed expectations. But residential real estate, a major engine of economic growth, has stalled. In November, the S&P/CoreLogic Case-Shiller Home Price Index fell -1.2%, its largest monthly drop in a decade.
US Stocks: November to remember.
U.S. equities gained for the 2nd straight month. Investors saw potential for the Fed to slow interest rate hikes on moderating inflation (recently 7.7% annualized) and subdued economic data. However, the possibility of further supply chain disruption over Covid lockdowns in China dampened enthusiasm going into December.
Foreign Stocks: Weaker dollar a plus.
A sharp drop in the U.S. dollar (-4.8%) aided most developed market equities, including in the Eurozone (+13.5%) and Japan (+9.7%). Emerging markets soared, led by China (+29.7%) and Hong Kong (+24.5%), on broader efforts to stabilize the struggling domestic real estate market and anticipated loosening of Covid restrictions.
Fixed Income: Inflation relief.
The news that U.S. inflation was lower-than-expected in November drove the yield on 10-year Treasury bonds down 30 basis points, one of the larger single-day moves in recent history. Both U.S. taxable and tax-exempt core fixed income rose (3.7% and 2.9%) while local currency emerging markets debt (+9.1%) was the star, given the weaker dollar.
Real Assets: Nice rebound.
While real assets didn’t fly as high as non-US equities, they were among the better performers in November. Commodities priced in dollars benefited from a weaker greenback, although oil was down -7.2% during the month, and the prospect of lower interest rates made the dividends from REITs (+6.4%) and infrastructure equities (+8.1%) more attractive.
Alternatives: Mixed results.
Hedge funds were relative underperformers in November, although generally accretive to client portfolios year-to-date. Relative value strategies (+1.6%) were a bright spot, benefiting from the shift in interest rate and bond trends on inflation good news, while managed futures strategies (-4.8%) were caught wrongfooted by these same shifts.
Source of data: Bloomberg
Equities Total Return
| NOV | YTD | 1 YR | |
|---|---|---|---|
| U.S. Large Cap | 5.6% | (13.1%) | (9.2%) |
| U.S. Small Cap | 2.3% | (14.9%) | (13.0%) |
| U.S. Growth | 4.4% | (23.1%) | (21.6%) |
| U.S. Value | 6.1% | (4.0%) | 1.9% |
| Int’l Developed | 11.3% | (14.5%) | (10.1%) |
| Emerging Markets | 14.8% | (19.0%) | (17.4%) |
Fixed Income Total Return
| NOV | YTD | 1 YR | |
|---|---|---|---|
| Taxable | |||
| U.S. Agg. Bond | 3.7% | (12.6%) | (12.8%) |
| TIPS | 1.8% | (10.9%) | (10.7%) |
| U.S. High Yield | 1.9% | (10.5%) | (8.9%) |
| Int’l Developed | 6.2% | (22.5%) | (23.1%) |
| Emerging Markets | 4.0% | (11.3%) | (10.7%) |
| Tax-Exempt | |||
| Intermediate Munis | 2.9% | (5.8%) | (5.7%) |
| Munis Broad Mkt | 5.1% | (8.9%) | (8.8%) |
Non-Traditional Assets Total Return
| NOV | YTD | 1 YR | |
|---|---|---|---|
| Commodities | 2.7% | 19.0% | 23.2% |
| REITs | 6.4% | (21.1%) | (15.3%) |
| Infrastructure | 8.1% | 2.1% | 8.8% |
| Hedge Funds | |||
| Absolute Return | (0.9%) | 0.3% | 1.3% |
| Overall HF Market | 0.0% | (4.5%) | (4.0%) |
| Managed Futures | (4.8%) | 20.6% | 21.1% |
Economic Indicators
| NOV-22 | MAY-22 | NOV-21 | |
|---|---|---|---|
| Equity Volatility | 20.6 | 26.2 | 27.2 |
| Implied Inflation | 2.4% | 2.7% | 2.5% |
| Gold Spot $/OZ | $1769 | $1837 | $1775 |
| Oil ($/BBL) | $85 | $123 | $71 |
| U.S. Dollar Index | 123.5 | 118.2 | 116.2 |
Our Take
There is a phrase in sports that “you’re never as good as your best day, and you’re never as bad as your worst day.” The lesson: success is best achieved by maintaining an even keel. A recurring takeaway in this space in 2022 has been “staying the course” in managing our portfolios, which are built to withstand short-term volatility in the pursuit of longer-term client objectives.
The markets keep providing us with excellent examples of why this sort of patience is warranted. To wit: International equities, which have faced unique headwinds in both Asia and Europe (and been portfolio underperformers this year) performed very well in November, with the weakening U.S. dollar accounting for most of the excess return relative to U.S. stocks. Last month, we pointed out that the U.S. dollar was at a lofty level and that some measure of a pullback wouldn’t be a surprise. This month, we continue to see the dollar as more than likely supporting, or at least not impeding, international investments versus the distinct headwind it had been for most of the last decade.
Toward the end of the November, investors cheered an inflation print for seemingly little reason: Year-over-year consumer inflation (CPI), which is a lagging indicator, came in at 7.7%, pretty good relative to economist expectations of 7.9% and October’s 8.2%. However, upon closer look, there was good reason for the cheering: Over the past four months (Aug.-Oct.), the pace of consumer price inflation has actually eased to +2.8% annualized from +12.2% over the prior four-month period. Looking even further into headline numbers cited by the Fed, core inflation over the past two months has actually been negative if one replaces the lagging CPI shelter component with the more current Case-Shiller Home Price Index.
While there are indications that inflation may be headed lower, albeit slowly, the economic landscape continues to offer conflicting signals. Despite the Fed’s dramatic monetary tightening thus far, U.S. unemployment remains historically low, fueling wage increases recently running at 5.1% annualized. Workers are still being squeezed, however, given that inflation has been running higher than wage increases, yet consumer spending has been seemingly resilient. For example, both Black Friday and Cyber Monday retail sales appear to be 6%-8% above 2021 in nominal terms although they are down when adjusted for inflation.
What does this mean? The Fed is almost certainly going to continue to raise interest rates in the months ahead, but the pace is potentially a bit slower, lowering perhaps the risk of severe economic pain. That said, we will not know the impact of the rate increases so far for quite some time, let alone the effects of future rate increases.
Eyes on the Prize
Strong and broad financial market results these last few months have been built around optimism that the Fed may be able to pull off a soft landing. With some signs that the economy is holding up alright, and after a couple of months of strong equity performance, it may feel to some like a market recovery is under way and there is no looking back.
However, such sentiment can and often does change quickly, with multiple instances of Fed policy expectation swings this year whipsawing investors. So, yes, we are maintaining an even keel as 2022 comes to a close but are excited about the opportunities this year’s dislocation in financial markets may present as we enter 2023. In general, with valuations and yields at more attractive levels, our longer-term return expectations for both stocks and bonds are back to levels we haven’t seen since early in the recovery from the Global Financial Crisis. Also, the dislocation in the capital markets this year, and potential dislocation to come in areas such as real estate, have created compelling opportunities to invest in a wide array of higher-yielding corporate credit and the reinvigoration of the U.S. supply chain.
