Strategic Income Outlook: Was This a Crazy Year or What?
Was This a Crazy Year or What?
2022 was a year for the record books – one we believe investors are happy to put behind them. Virtually all asset classes fared poorly due to inflationary pressures rearing up after being dormant for many years, exacerbated by the uncertainty of war. We have discussed the reasons for low inflation in past outlooks and do believe that we are entering a new era with both higher inflation and interest rates. Once the markets have adjusted for the absence of free money (or in the case of Europe, “pay you to take it” money), what comes next? Barring a black swan event, life will continue, coping mechanisms will take hold, and markets for financial and real assets will find their equilibrium. Sometimes it helps to take a step back to have a broader view of what markets are offering today versus what we have gotten accustomed to in the past decade or so in order to find the right path to better returns.
Equities, bonds across the ratings spectrum, cryptocurrency, SPACs, etc. all had a bad year. Some have called it the everything bubble. While some energy commodities did well, we believe the factors responsible for that are not repeatable, hopefully. Eventually, supply and demand will come back into balance, so we do not expect a repeat of 2022. We have already seen a round trip in prices of some commodities like lumber, aluminum, steel, and wheat while others are down from their 2021 peaks but still have further to go. Treasuries had an especially bad year, despite their year-end rally. As we have stated in the past, the math of starting a tightening cycle from historically low yields would certainly bring tears. And it has. It is even worse in Europe, where yields were negative to start. Insanity.
For equities, the biggest driver of negative returns has been the contraction of multiples caused by the rise in interest rates. The question remains: How much further do we have to go, and will the E in the P/E start to shrink, making it a vicious circle? For most of 2022 there was a widespread belief that weak economic data would cause the Fed to lose its nerve in its fight against inflation and pivot to a more accommodative monetary stance, despite Fed messaging to the contrary. Whenever weaker economic data hit the tape, equity markets would rally, as would Treasuries. We thought it odd that a rise in the prospects for a recession would be a cause for celebration given what has typically happened to equities during past recessions. Hint: they have not fared well. Temporary insanity? Maybe.