US Sector 7D Performance – December 15, 2022 – Simply Wall St
This week we’ll look back at 2022 and consider where we are as we head into 2023. A year has passed and a lot has happened – it’s time for a quick look back!
Plus, this will be our final market insight for 2022 before we take 2 weeks off and resume again on January 9!
2022 in the rear view mirror
The year began with a strong global economic recovery in the wake of the post-Newcastle epidemic and supply chain bottlenecks beginning to ease.
Global markets largely reflected the optimism, with major equity indices hitting record highs in November 2021 and December 2021.
Inflation is rising, but central banks are reluctant to raise interest rates. The theory is that inflation is “temporary” and will decline as the economy normalizes. As of 2021, the U.S. 10-year Treasury yield is 1.51%, well below where it has been for most of the past decade.
First quarter: war breaks out, rate hikes begin
Markets began to decline early in the year as inflation continued to rise and tensions between Russia and Ukraine began to escalate. Interestingly, the sectors that performed best in January continued to outperform for the rest of the year. Crude oil and gold also began to rise early in the year as geopolitical tensions increased.
On February 24, Russia invaded Ukraine, triggering a new supply chain crisis. Crude oil prices touched $129 in March, which may have been the final nail in the coffin of the temporary inflation theory. in late February, we outlined potential opportunities for energy stocks, as well as potential risks to growth stocks. Both have yielded some results.
The Federal Reserve raised interest rates by 0.25% in early March. This was lower than expected and the market rallied towards the end of the quarter. However, the first rate hike marked the beginning of what may be the steepest rate hike cycle in history.
Current vs. past U.S. rate hike cycles – Image credit: Federal Reserve
During the first quarter, the Morgan Stanley Capital International World Index fell 6% and the S&P 500 Index fell 5%, although both indices ended the quarter well below their lows.
Second Quarter: Reality Begins
During the second quarter, investors faced worrisome news on several fronts.
Global inflation continued to rise. in April, the U.S. consumer inflation rate was 8.5% in March, the highest level since the 1980s. Prices rose at a similar pace in Europe and elsewhere.
The Federal Reserve raised interest rates by 0.5 percent in May and began warning that rate increases could become more aggressive. Elsewhere in the world, central banks began to raise rates or indicated they would soon do so.
Mortgage rates around the world began to rise sharply and it became clear that the already overheated housing market was in trouble. While home prices did not fall immediately, global home sales fell sharply.
The 2-year/10-year yield curve inverted – an indicator that has predicted most recessions in the past.
U.S. GDP in the first quarter was surprisingly negative.
As investors digested these developments, markets plunged. the MSCI World Index fell 14 percent during the quarter, while the S&P 500 fell 16 percent. Most of the world’s major stock indices fell into bear market territory – down more than 20 percent from their highs. Riskier assets fared even worse. The popular, growth-oriented ARKK ETF fell 40% during the quarter, and bitcoin dropped 56%.
The yield on the U.S. 10-year Treasury rose to 3%, twice what it was at the beginning of the year. The only asset worth owning was the U.S. dollar, which continued to rise for the fourth consecutive quarter.
During the second quarter, stocks were repriced to reflect higher interest rates. P/E ratios fell sharply, but in most cases, earnings were not affected. In fact, earnings growth was very strong in the second quarter. This created the illusion that stocks were cheaper than they actually were .
Third Quarter: Earnings Expectations Decline
Despite the gloomy outlook, the market ended the second quarter with another bear market rally that continued into the middle of the third quarter. The rally lost momentum as another round of negative news began.
The Federal Reserve warned that rate hikes could last for some time. The U.S. fell into a technical recession, although policymakers said it was not yet complete.
In Europe and the U.K., things are starting to get scarier as Russia cuts off gas supplies to Europe. The euro is level with the dollar for the first time in 20 years, and the U.K. is likely to fall into recession by the end of the year.
Deteriorating Chinese economic data led to an unexpected interest rate cut . Global markets are increasingly concerned that the crisis in China’s real estate market could spread to the entire financial system.
Corporate results in the second quarter began to show the impact of inflation and a stronger dollar on profit margins. In the third quarter, analysts began to lower their earnings per share estimates, which by the end of the quarter had fallen by 6% and foreshadowed a potential earnings peak.
The next round of selling gained momentum when inflation continued its unexpected upswing. By the end of the quarter, stocks fell to a new 52-week low, but quickly rallied again as speculation increased that the Federal Reserve would turn.
Fourth quarter: cyclical rebound
The fourth quarter began with turmoil in the UK. Liz Truss replaced Boris Johnson as Prime Minister, but her economic plans were quickly rejected by investors. The British stock and bond markets were hit hard and the pound touched a record low of $1.035. By the end of October, Rishi Sunak took office, giving Britain its third prime minister in two months.
The third-quarter earnings season was better than expected – but expectations were low. While earnings per share showed single-digit growth, they were actually negative when excluding the impact of energy stocks, which reported a 140 percent increase. Early in the earnings season, estimates for Q4 earnings per share indicated a year-over-year decline.
Economic forecasts for the fourth quarter suggest that most countries will be close to recession in 2023 and recover by the end of the year.
While profits are under pressure, consumers are showing resilience. Consumer budgets are stretched, but consumers are not overextended yet. Most (but not all) retailers are struggling.
Despite the lack of encouraging news, the market rebounded in the fourth quarter. In a growing number of new commodity supercycle cases, cyclical sectors, particularly oil and energy, are beginning to show relative strength. This is despite the fact that oil prices have fallen by more than 40% since March.
As of Dec. 14, the MSCI World, U.S. and European indices have recovered about half of their losses for the year. Overall, investors seem to be pricing in a Santa Claus rally and a soft landing.
What does this leave us with?
As of mid-December, the U.S. stock market was down about 18% in 12 months. The energy sector is up 52% and is the only sector in the green. Utilities and consumer staples have proven themselves to be more defensive sectors and are almost flat. Healthcare underperformed on the defense side, losing 8% as the sector continues to normalize after the pandemic.
Other cyclical sectors (materials, industrials and financials) have rebounded in the past two months, losing less than 10 percent. The interest rate and growth sensitive U.S. Telecom, U.S. Technology, U.S. Real Estate and U.S. Consumer Non-Essential sectors remain deep in negative territory.
U.S. Sector 1-Year Performance – December 14, 2022 – Simply Wall St
Among other assets, the dollar index has fallen from a high of 114 to 103 from 95 at the start of the year. 10-year bond yields have fallen from a high of 4.29% to 3.4%, and oil prices have fallen 40% since then.
Inflation is falling – very slowly – and the market seems to expect interest rates to stop rising soon.
However, markets may still be at odds with the Fed’s policy, as the central bank’s latest forecast shows interest rates will reach 5.1 percent by the end of 2023
The Insight: Hard Landing and Soft Landing Still Under Discussion
A hard landing would mean that central banks would have a really hard time controlling inflation. If that happens, they will continue to raise interest rates, which will put more pressure on consumer spending, investment and ultimately on corporate profits. This could mean a severe recession and rising unemployment.
If inflation falls to a manageable level, the central bank will stop raising rates and there will be a soft landing. Economic growth could fall to near zero (there is not much difference between a positive and negative change of 0.5% of GDP), but would recover quickly.
Both scenarios could still happen. Economic forecasts are mixed, but some are starting to improve.
What this means for investors
The prospect of a hard landing may seem less attractive to investors, but it is important to remember the words of our friend Warren Buffett, who implores investors to “be fearful when others are greedy and greedy when others are fearful”. Difficult times in the stock market are tough times to hold stocks, but they are tough times to hold stocks in a way that you might think of as
