This past year marked the end of the cheap money era. Since the Great Financial Crisis of the late 2000s, central banks around the world implemented low interest rates as a way to stimulate growth. This era, known as the “cheap money” era, saw a surge in risky investments in technology stocks, cryptocurrencies, and special purpose acquisition companies (SPACs). However, when the COVID-19 pandemic hit and central banks continued their loose monetary policies it created inflation.
In response, central banks had to raise interest rates to combat high consumer prices. This sudden shift signified the start of a new era for the global economy that will prioritize traditional business values such as stability and profits. This is why value companies such as Berkshire Hathaway outperformed companies that had sky high growth rates. Next year, I expect that higher borrowing costs will continue to slow economic growth and decrease corporate profits. This will put more stress on financially unstable and heavily indebted firms. As interest rates rise, the cost of servicing this debt will also increase, which could put pressure on weak businesses and overleveraged consumers. Companies with high cash flows should continue to outperform in 2023.
This was an outlier of a year as higher interest rates hit both stocks and bonds. There were a number of other factors that contributed to market uncertainty in 2022. These included the Fed raising interest rates at the fastest pace in history, political tensions, the war in Ukraine, and the bursting of the technology bubble. 2022 was a unique year for investing due to a number of factors, including higher interest rates, which impacted both stocks and bonds. I recognized the growth bubble and was able to avoid significant damage in the NASDAQ, which fell 32.58% last year. However, a new generation of investors learned firsthand the lessons of the 2001 and 2009 market crashes. For example, the NASDAQ 100 fell 83% from its high from March 2000 to October 2002, a period of 31 months. Similarly, the ARK Innovation ETF, which has been a popular choice for speculative investors this year, fell 81% from its high in February 2021 to its recent low. This occurred in just 22 months, which demonstrates the rapid pace at which losses can accumulate in a market crash.
In 2022, it was challenging because nearly every investment seemed to decline to some extent. This made it difficult to diversify portfolios and mitigate risk. Looking ahead to the next year, I expect that there will be a renewed interest in fixed income investing as it becomes more of a “saver’s market.” This shift will likely require investors to adopt a more selective and profit-driven approach, moving away from speculative investments in stocks. The transition to this new era may be rocky, but it could also present opportunities for higher returns. If interest rates continue to rise, it could increase the returns on safer investments such as short-term bonds and treasuries. While the transition has been difficult, it may also set up the opportunity to buy companies at a discount.
The chart below illustrates the challenging year that investors faced in 2022. The vertical axis represents the annual return for US bonds, and the horizontal axis represents the annual return for US stocks. This chart demonstrates that 2022 was a particularly difficult year for both bond and equity investors, as there has never been a year since 1871 in which returns for both asset classes were so low. However, it’s important to note that when the market falls as much as it did in 2022, it often experiences a rebound in the following year. This can provide an opportunity for investors to capitalize on the recovery and potentially achieve higher returns.
The performance of individual stocks can be influenced by a variety of factors, and the relationship between economic growth and the performance of growth stocks is not always straightforward. However, it is possible that a short-term economic slowdown could lead to an expectation that the Federal Reserve will lower interest rates, which could lead to a rally in stocks.
In 2020, the stock market saw a rally even as lockdowns and other measures were implemented by the government to manage that crisis. This demonstrates that investors are always on the lookout for undervalued securities and are willing to buy into short-term dips in the market.
Last week, Southwest Airlines experienced a systemwide chaos that resulted in the cancellation of thousands of flights and stranded hundreds of thousands of customers during its busiest week. Despite this, the stock rebounded later in the week and only finished down a few dollars. This shows that there is a limit to the selling even in the worst of times, and many investors are willing to buy into short-term dips.
As we head into 2023, it’s important to maintain a long-term view of the market. The stock market has a tendency to bounce back when you least expect it, and interest rates could also fall unexpectedly. Your portfolio is diversified and I’ve considered all the factors such as your risk tolerance, time horizon, and investment goals.
