Looking Forward to a New Year

| January 10, 2023 | 0 Comments

As 2022 winds down and we start thinking about how to work off the pecan pie and holiday celebrations, folks often naturally wonder what the new year has in store. For most of us, this feeling will be particularly acute as we open our brokerage statements in January. 2022 has been one for the record books, and not in a good way.

2022 has been a year in which virtually every investment category lost money simultaneously. As I write this article before the Christmas holiday, the S&P 500 index of large company stocks is off about 18.5 percent. The kicker, though, is that rising interest rates have caused bond values to plummet at the same time as stock prices. The Bloomberg US Aggregate Bond Index (which covers government and corporate bonds and is considered a broad proxy for the entire bond market) is also down about 12 percenet. International stocks and real estate have also had a tough year. Bonds haven’t had a year this bad since 1974.

With a year like that, it’s natural to wonder how 2023 is going to compare to 2022. As we consider this question, bear in mind that the best forecasters on Wall Street get about three out of five of their predictions wrong, so there’s a BIG grain of salt to go with this article. With that caveat aside, let’s consider the situation.

During 2022, the Federal Reserve (“Fed”) has been raising interest rates in an effort to bring down the inflation that’s plagued consumers and businesses this year. The reason this cools inflation is that rising interest rates tends to slow down the economy, reducing the demand for goods and services. So far, it appears that inflation is starting to cool, but not enough to satisfy the Fed, so more interest rate hikes are likely, though more measured than we’ve seen this year.

The challenge is that the Fed has almost never been able to raise interest rates without also slowing the economy to the point of causing a recession, and the consensus is that’s likely what will happen in 2023 as well. So, in a recession, unemployment rises, consumer spending slows, house prices typically drop a bit, and so-on. The good news is that the average post-WWII recession lasts only about 10 months, and most forecasters seem to think that if there’s a recession next year, it could be fairly mild.

The bad news is that the stock market typically falls heading into a recession and the average peak-to-trough decline is about 40 percent. If stocks are already down about 20 percent from their peak, that suggests we could see another 20 percent decline from here before they begin to recover. That is NOT guaranteed; the drop could be more or less. On the plus side, if we do have a recession, the Fed will likely be forced to lower interest rates, meaning that bonds could be better investments next year than in 2022.

The challenge is that nobody can say for certain when stocks will fall. More importantly, it’s nearly impossible to say for certain when they will begin to recover, either. Historically, the stock market typically begins to climb long before the economy has begun to recover and often long before it feels safe to invest in stocks. This makes trying to time the market by selling stocks now and buying them later “when it feels safe” a losing proposition.

The best, most reliable strategy for dealing with a recession and the resulting drop in the stock market is to make sure you have enough funds to cover your expenses, so that you don’t have to dip into your portfolio when it’s lost value.  

Disciplined investors will rebalance their portfolios periodically, selling bonds as they gain in value and buying stocks or other assets as they get cheaper. This is the most reliable way to deal with market volatility and should be much more effective if we’re right about 2023. It’s even possible that the stock market has fully recovered by the end of next year.

Nobody can be certain about the future, yet, having a plan and sticking to it is a very reliable way to navigate the ups and downs of investing.

Wishing you Happy Holidays and a Happy New Year!

This column is prepared by Rick Brooks, CFA®, CFP®. Rick is director/investment management with Blankinship & Foster, LLC, a wealth advisory firm specializing in financial planning and investment management for people preparing for retirement. Brooks can be reached at (858) 755-5166, or by email at rbrooks@bfadvisors.com. Brooks and his family live in Mission Hills.

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