The fourth quarter concluded with a two-week selloff in both the stock and bond markets, a fitting end to a year filled with a myriad of economic challenges and broad-based uncertainty. For the year 2022, the S&P 500 index finished down 19.4% while the technology focused NASDAQ composite declined 33.1%. Most unusual was the in tandem decline of both stock and bond prices, making it the first time since the late 1960s that these broad asset classes fell together. The U.S. economy also labored throughout the year, registering two consecutive declining quarters of gross domestic product (GDP), thus meeting the technical definition of an economic recession. The all-important real estate sector also struggled as higher mortgage rates impacted demand, culminating in a November housing report of an 8% price decline for the year.
On the bright side, we know that economic contractions and bear markets are normal occurrences, setting the stage for the next expansion and a new set of investment opportunities. As it relates to the U.S. economy, there is an ongoing debate about the timing and severity of a recession in 2023, or whether it can be avoided all together. An optimistic perspective points to a labor market that has been especially strong, bolstered by forecasts for additional job gains, moderate wage growth, and a low unemployment rate of 3.5% recorded in December. In addition, the recently signed $1.7 trillion omnibus bill, combined with the $400 billion Inflation Reduction Act, should provide substantial government stimulus to further support business activity. Lastly, overseas, the re-opening of the Chinese economy, on the heels of strict COVID lockdowns, has the potential to reinvigorate supply chains and increase trade, further boosting the global economy.
As it relates to inflation, the Fed has been pleased with readings from the Personal Consumption Expenditures price index (PCE), a key inflation measure that has been moderating in recent months. Looking ahead in 2023, the key narrative will continue to be rising prices, with the focus on how much success central bankers have in their quest to bring inflation under control. With the closely followed Consumer Price Index (CPI) just registering its sixth straight monthly decline, the Fed is seeing evidence that inflation is coming off the boil and that their tight monetary policy has had the intended effect of slowing the economy and tempering prices. Stock and bond investors are watching these dynamics closely, searching for signs of a pivot in monetary policy that could change the tone of the financial markets for the better.