As 2022 becomes only visible through the rearview mirror, we can begin to quantify the damage and name the causes for so much of what has happened throughout the calendar year.

    1. Highest Annual Inflation since 1982 (8.5%)

    2. Most Fed Rate Hikes In a Single Year (0 to 4.5%)

    3. Worst Year for US Aggregate Bond Index in History (-14.96%)

    4. Fastest Rise in Mortgage Rates Ever Recorded (3.22% to 7.08%)

    5. S&P 500 Notches 7th Worst Year since 1928 (-19.4%)

1. Highest Annual Inflation since 1982 (8.5%)

Inflation spiked higher beginning February 2021 and into 2022 but by February 2022 when the Consumer Price Index reached 7.9%, Federal Reserve Chair J. Powell dropped the position forecasting that inflation would be transitory and began speaking of rate hikes in 2022 to combat the growing risks of inflation. Inflation persists still today, but the November 7.1% rate announce in December 2022 is steadily lower than the 9.1% rate measured in June. Inflation damages the economy in two ways. First, inflation which gets absorbed by businesses due to higher costs reduces the corporate profits or in market terms, the earnings per share for the shareholders. Secondly, inflation which gets absorbed by the consumer due to flat wages but higher costs will manifest itself in a change in purchasing behavior. This often comes in a reduction of spending on non-essential items and can also be measured through increased purchase of generic brands or sale items.

2. Most Fed Rate Hikes In a Single Year (0 to 4.5%)

Mid-2021, consensus from many analysts and economists was that inflation was transitory and the Federal Reserve would not raise interest rates much if at all in 2022. At the June 2021 meeting, the FOMC dop plot summary also showed that 13 of the 18 members expected the Fed Funds rate to be below 1.0% in eighteen months, now, January 2023. As we are aware, the Federal Reserve and analysts/economists grossly underestimated the stubborn nature of inflation caused by the COVID stimulus efforts. The Federal Reserve only raised 0.25% in March, but quickly followed with 0.5% and four 0.75% rate hikes at subsequent meetings through 2022. The Federal Reserve began to see a meaningful reduction in inflation (chart 1) June through November 2022 which caused the rate hike in December 2022 to be reduced to only 0.5% to a range of 4.35% - 4.50%. The December announcement included guidance of smaller rate hikes in 2023. These actions continued to drag stocks lower through 2022. Nearly every bear market rally in 2022 was caused due to sentiment suggesting the Federal Reserve was coming within six months of an end to rate hikes. The great debate continues still; if inflation continues lower through the first half of 2023, perhaps the equity markets can stabilize with a reasonable -20 to -30% loss since peak, January 4, 2022. If however, inflation persists in an ongoing harmful level causing the Federal Reserve to continue raising rates in 2023, the equity markets could respond with further losses beyond -30% depending on the ongoing inflation reports.

3. Worst Year for US Aggregate Bond Index since 1842 (-14.96%)

Bonds are added to a portfolio to add stability, however stable losses are seemingly what investors received through 2022. This marks the worst calendar year losses for the bond market since 1842 which was the second worst only outdone by the near 25% losses in 1792 when Alexander Hamilton was Treasury Secretary and the United States was only in its 16th year of existence facing its first economic depression. The 12-month period ending March 1980 was a period of greater losses than 2022 (just not an exact calendar year). In 1980, CPI hit 15% and the bond market dropped 17% over the twelve month period. The bright spot for 2022 is that the bond market decline into 1980 launched a +40 year bull market for bond investors. Owning individual bonds provides peace of mind about forward returns. Bonds which traded at premiums in 2021 were always only going to mature at par. Those same bonds which are now trading below par, will still repay their par value at maturity. Investors in bond mutual funds don't have the same clarity as large outflows from the fund could cause the manager to be forced to liquidate bonds below par, preventing the investor's participation in the return to par over the coming years. The long & short of the bond market performance in 2022 is that some of the -14% loss would have happened anyway in the coming years, and now, some of the -14% loss will still be recovered by investors in the coming years.

4. Fastest Rise in Mortgage Rates Ever Recorded (3.22% to 7.08%)

Housing matters to inflation and economic stability because currently, the real estate industry accounts for nearly 17% of national GDP. In November 2022, housing still accounts for 33% of all inflation, the most of any category. By raising the Fed Funds Rate, the Federal Reserve changes the mathematics behind consumer behaviors. While a 6% 30-year fixed rate mortgage is historically average, the rate situationally seems drastically high compared to the 3% mortgage which was available earlier in 2022. While a slowdown in housing helps bring down inflation, a slowdown also reduces national GDP. This slowdown reduces the revenue of financial institutions, suppliers, transportation companies and the overall employment need to satisfy the reducing demand. Past housing bubble bursts have dragged the US economy into recession due to the spiraling nature of the decline and the widespread impact of the sector.

5. S&P 500 Notches 7th Worst Year since 1928 (-19.4%)

Notably, the Dow Jones Industrial Average (.DJI) declined only 8.78% compared to the 19.44% S&P 500 Index (.SPX) decline and the 33.1% decline of the NASDAQ (.IXIC). Generally, these three separate indices track within close relativity to one another. The disruption of inflation is driving a deep wedge between the mature cashflow oriented business tracked by the .DJI compared with the younger growth-focused companies listed on the NASDAQ exchange. Our real benefit in being index oriented investors is that the portfolio participates in each sector listed above. While we did have some exposure to the worst performing communications sector, we also had exposure to the best performing energy sector. This exposure and the ultra-low costs are the benefits we reap while also being reminded that in 2021, 85% of active investment fund managers underperformed the S&P 500 and clients paid high fees to participate in that underperformance. Shortly, we'll know how active investment fund managers performed against the index in 2022, but since 94% have underperformed the rolling 20 year average, we must keep our mind from chasing performance and guessing which sector will lead next. The performance of active managers is according to S&P Dow Jones Indices research which can be accessed below.

https://www.spglobal.com/spdji/en/documents/spiva/spiva-us-year-end-2021.pdf

Thank you for following along & for trusting me as your advisor. This market commentary will continue regularly. Please share this article with anyone who may benefit & contact me directly with questions or comments.