Q1 2023 Commentary: Back to Business

2022 A tale of two forces: Inflation and the Fed

The year 2022 was an unpleasant one for investors. The Dow Jones Industrial Average (30 stocks) and the broader-based S&P 500 (500 stocks spread across major industries) peaked as the year began (Yahoo Finance data).

The Fed’s response to stubbornly high inflation prompted the fastest series of rate hikes since 1980, according to data from the St. Louis Federal Reserve.

While we would never discount the severe humanitarian crisis that has unfolded for our friends in Europe, market woes were compounded by Russia’s illegal invasion of its neighbor.

The war on Ukraine exacerbated inflation by temporarily sending oil prices much higher and lifting commodities such as wheat.

The allied response designed to punish Russia also trickled into financial markets.

Put another way, the favorable economic fundamentals we were treated to in the 2010s—low interest rates, low inflation, and modest economic growth shifted dramatically last year.

The economy expanded, but the interest rate and inflation environment overwhelmed any tailwinds from economic and profit growth.

Notably, however, the returns on major market averages varied widely. The Dow lost 8.8%, while the S&P 500 Index gave up 19.4%, the biggest disparity in over 60 years, according to CNBC.

Furthermore, the tech-heavy, growth-heavy Nasdaq stumbled badly amid the high-rate environment.

In hindsight, it’s not surprising, as we’d expect fast-growing firms such as technology to be the most sensitive to higher interest rates. A slowdown in growth in the sector compounded problems.


Key Index Returns

Dow Jones Industrial Average -4.2 -8.8
NASDAQ Composite -8.8 -33.1
S&P 500 Index -5.9 -19.4
Russell 2000 Index -6.6 -21.6
MSCI World ex-USA* -0.6 -16.6
MSCI Emerging Markets* -1.6 -22.4
Bloomberg US Agg Total Return -0.5 -13.0

Source: Wall Street Journal, MSCI.com, MarketWatch, Bloomberg

MTD returns: November 30, 2022-December 30, 2022

YTD returns: December 31, 2021-December 30, 2022

*in US dollars


The disparity between the Dow and the S&P 500 is puzzling at first glance. When looking at just the Dow, one might be tempted to ask, “What bear market?”

Or, don’t both indexes basically cover the same industries? Well, not exactly.

If you look under the hood, the answer surfaces.

“The Dow has done better because it was underweighted in those areas that fell the furthest and overweighted in those areas that did better,” said Sam Stovall, chief investment strategist at CFRA Research.

The Dow also benefitted from its more defensive composition, including a heavier emphasis on health care.

Despite the wide disparity last year, over time the index performance tends to correlate more closely.

Key numbers

In recent years, uncertainty in equities has aided bonds, as investors sought safety in fixed income.

Last year was a notable exception. The yield on the 10-year Treasury bond rose from 1.63% at the beginning of the year to 3.88% by year-end (U.S. Treasury Dept). Bond prices and yields move in opposite directions, which pushed bond prices down.

The drop in bond prices can be traced to the sharp rate hikes from the Federal Reserve.

Inflation is the root of the problem. A year ago, the Fed belatedly recognized that 2021’s surging inflation wasn’t simply “transitory,” its word of choice at the time.

As our clients know we take a less traditional approach to investing and to the markets as a whole and we see 2023 as a very exciting time for the markets and our approach.  Our bond alternatives performed very well in 2022 and while we were not immune to losses in the equity markets we did find opportunities to make adjustments and saw smaller losses than the overall markets.  We are anticipating rates to continue to rise in the early part of 2023 and then stabilize as inflation continues to fall.  We do not anticipate the Fed cutting rates in 2023 unless unemployment becomes a big issue which we are not expecting at this time.  2023 is shaping up to be a more normal year for the markets, if there is such a thing any more.  A lot of the forces that effected things in 2021 and 2022 are finally behind us.