The Year in Review: Wealthspire Advisors 2022 Q4 Review
Throughout this year, we have spent significant time discussing inflation and the Federal Reserve, so we felt it was important to pivot towards the story in financial markets for 2022, which begins and ends with fixed income. The headline grabbing 2.50-4.50% rise in interest rates corresponded with a decline of 7% to 15% in value for bonds, depending on particulars. We have come to expect the losses we saw in the equity markets (down 9% to 35%, again depending on the specifics), but losses in fixed income were historic and led to similarly historic declines in any balanced equity/fixed income portfolio. Perhaps the starkest statistic showing just how rare 2022 was, was that since 1936, there has only been one other year in which both stocks and bonds were negative, and in that year, 1969, stocks were only down 8.4% and bonds only 0.74%.
The primary reason for fixed income’s declines was the continued rise in inflation, its evolution from transitory to more ingrained, and the Federal Reserve’s sprint to raise rates to try and reign it in. A compounding factor, and a point we have made repeatedly, was that at the yields found in the fixed income markets at the beginning of the year, there was little buffer to the impact of a rise in rates. Now with yields up and interest rate duration down, the Bloomberg Aggregate fixed income index, the most frequently cited index, is able to withstand a much greater move in rates and still generate a flat to positive return moving forward one year. More specifically, a 0.75% move up in rates at the beginning of 2022 would have resulted in a decline of -3.30% in the index. At current levels, the index would be flat.
Much ink has been spilled of late with articles bemoaning the death of the 60/40 portfolio and similar equity/fixed income balanced portfolios. We would say this is too backward biased. As we have pointed out, the path of recent market performance sets the stage for future performance, usually momentum in the opposite direction, or “mean reversion” in finance speak. 2022’s poor performance left equity valuations and fixed income yields much more conducive to future performance. All else equal, lower equity valuations and higher fixed income yields should result in more robust future performance than the opposite.
See below for a scatter plot of quarter-end S&P 500 price/earnings levels going back to 1990 and yield-to-worst of the Bloomberg Aggregate Bond Index. For the avoidance of doubt, an investor ideally would be facing levels in the upper left quadrant (low valuations and high yields).
In the recent past, we have bumped along in the lower right quadrant: equity valuations had rarely been higher and yields on the Bloomberg Agg index had never been lower. Where do you allocate if everything is expensive? The investment community in fact coined a somewhat depressing term reflecting this dilemma, “There is No Alternative” or TINA. We did our best to set (conservative) expectations, using the lowest capital markets assumptions we had ever used in our financial plans. We are now sitting decidedly in historically normal levels, and as a result we are in a much better starting point than we have been in a long time, also reflected in our more optimistic capital markets assumptions currently in use. We do not think the 60/40 portfolio is dead.