SFM 4th Quarter Update 2022

Market Synopsis: Fourth Quarter 2022

2022 was a tumultuous year for investors as both public stock and bond markets declined in value. Due in large part to a mix of inflation, rising interest rates, the war in Ukraine, and midterm elections, investors struggled to find positive gains in a difficult year. Unlike past downturns the “safety net” of bonds was not there this year as bonds declined by historic levels along with stocks (a very rare event), which made this the worst year for a blended portfolio of “60% stock & 40% bond” since the Great Depression in the 1930s, with a return of -16.1% in 2022. The fourth quarter saw a small recovery off the lows of the year, but still ended mixed as some areas of the investment markets stabilized more than others. There are some positive signs as the fourth quarter saw the midterm elections split the house and the senate between democrats and republicans. Regardless of how you feel about politics, a split government has historically been a good thing for markets as very little new legislation gets passed and investors like the clarity of the status quo. 

Despite the political logjam, there was a very important piece of legislation passed with the Omnibus spending bill to end the year. Included in the bill was a host of changes to retirement savings and tax rules around retirement accounts, many of them positive changes that will help people save for and support retirement goals. Among the more than 90 retirement related changes, one of the most notable includes pushing back required minimum distributions (RMDs) from IRAs to age 73 beginning in 2023 and then pushing it back again to age 75 in 2033. This means, for anyone turning 72 in 2023, your RMD will be pushed back one year until 2024. Another major change added in the bill is allowing unused 529 college savings plan money to be converted to a Roth IRA for the beneficiary. This is a positive change that makes these college saving accounts more attractive, especially for anyone worried about contributing too much to these accounts and having some money left over that wasn’t needed for education…to ensure it can continue to grow tax-free. 

The S&P 500 index (large company US stocks) was up +7.6% in the 4th quarter, but still finished the full year 2022 down by -18.1%. The Nasdaq stock index (composed of faster-growing technology companies) struggled further in Q4 down -0.8% and down for the year -32.5%. The larger decline in growth and technology companies resulted from rising interest rates and expectations of slowing growth, which hurt these stocks more than their slower growing peers since investor expectations were much higher. Some examples of these types of stocks that are widely-owned for our clients and lagged in 2022 included the business software company Microsoft -28.0%, the online advertising firm Alphabet -38.7%, and the e-commerce leader Amazon -49.6%. These are all stocks that you have owned for long time periods and have very large cumulative profits, and these are still companies we believe in long-term as we believe their competitive advantages are as strong as ever. So, while these and other stocks you own experienced short-term resets in their stock prices this year, we still want to own these companies due to their long-term outlook and strong recovery potential. Despite the sell-off that continued for some companies in the 4th quarter, other stocks you own rebounded in the quarter. The snack food and beverage giant Pepsi was up +11.3% in Q4 for a total gain of +6.8% in full year 2022. The conglomerate run by Warren Buffett Berkshire Hathaway was another stand-out performer this year returning +15.7% in  the 4th quarter and +3.3% in 2022 overall. Payment processing was another area that rebounded in the 4th quarter with both Mastercard and Visa earning impressive returns during the 4th quarter of +22.5% and +17.2%, respectively, while both returned a slight loss of only -3% for the full year. Healthcare also saw some positive gains with the orthopedic implant producer Stryker up +20.7% and the laboratory supply company Thermo Fisher Scientific up +8.6% over the final 3 months of the year. Overall, stocks struggled during the full year 2022, but there were signs of a positive turn to end the year. 

Bonds also recovered slightly in the fourth quarter with the Bloomberg US Aggregate Bond index up +1.9%, but still ended the full year of 2022 down by -13.0%. This was the worst year for the bond market since they have been tracking it. With the Federal Reserve raising interest rates at an unprecedented historic pace, bond values plummeted more than any other year. As long as investors hold on, these losses should all be recovered since bond owners will still receive the initial value of the bond back plus the annual income, however they will need to hold until the bond reaches maturity. Looking forward, we expect that the global reset in interest rates will be a good thing for investors as these bonds (and all newly issued bonds) are now paying substantially higher annual income going forward. For example, this time last year a 2 year Treasury bond, one of the safest investments because it is backed by the US Gov’t, was paying income of less than 1%/year and is now paying income of 4.4%/year. It has been a long time since investors were able to get a risk-free investment paying 4.4%. This means that future annual returns from bonds will be much higher than they have been in the past. In the 4th quarter we were able to take advantage of this interest rate reset for our clients by purchasing various FDIC-insured CDs that pay annual income of +4.7% to +4.9%/year with no risk. Additionally, we moved more of our clients bond allocation into the WisdomTree Floating Rate Treasury ETF that is also risk-free and completely backed by the US Gov’t. It is currently paying income of +4.4%/year and this income will rise along with future interest rate increases. 

One area of your portfolio that continued to earn good performance in the 4th quarter and the full year of 2022 were the alternative investments, which showed gains in both time periods for most clients. The strongest gain in the 4th quarter was earned by the Versus Real Assets Fund, which was up +3.5% in the 4th quarter and +4.0% in the full year 2022. The private real estate holdings performed well for the full year, but lagged slightly in the 4th quarter as the Blackstone Real Estate Income Trust, for example, gained +10.7% for the full year 2022, but returned -0.3% in the 4th quarter. The private debt category also helped provide strong positive performance in a tough year with the Cliffwater Corporate Lending Fund gaining +6.5% for the year and +2.0% in the 4th quarter. Along with our other alternative investments, these positions helped provide important diversification to balance out the down year for stocks and bonds since as a category alternatives benefited from higher inflation and rising interest rates. Private real estate investments have begun to work in the impact of higher rates into their valuations, tempering the returns they’re delivering to end the year despite rising rents continuing to increase. Also, in the fourth quarter both Blackstone and Starwood, two of the largest private real estate funds in the country, limited withdrawals from their funds (to protect the remaining owners like us from them needing to sell buildings too quickly below what they are worth) as investors were rebalancing portfolios and trimming the only positions that had gains in 2022 (such as these alternative investments). We favor this limitation on withdrawals as it ensures Blackstone is not forced into selling properties at reduced prices just to meet investor withdrawals.

Inflation (or the rising costs of goods and services) was one of the primary drivers of the market decline in 2022. It’s important to realize that many of the issues we are working through in the investment markets are due to the sudden inflation spike in 2022 (rising to as high as +9.1%/year before falling recently to +7.1%/year levels) and the government response to get it under control. The US Federal Open Market Committee’s (FOMC) response was to raise interest rates (to help reduce inflation), which leads to higher borrowing costs for businesses and consumers and slower economic growth. Inflation has remained very low for the last 30+ years, and the global expectations are still that inflation will fall back closer to these lower levels in the next 2 to 3 years. This is one of the many reasons to keep a positive outlook as inflation seems to have peaked already and all indications are that it is slowing and starting to decline. As it becomes clearer that high inflation levels are behind us, and profit growth for business will resume, and the investment markets will stage a sustainable rebound…but this may not come until later in 2023 or even potentially 2024 so we urge you to remain patient and stay-the-course with your investments.

To summarize, the 4th quarter saw some positive gains in many investment areas, but volatility stayed high and 2022 finished down sharply for the year. Despite the short-term pain this year, when put into perspective given the rapid rise in markets (and your SFM investment account) over the past 5-10 years, even through Covid-19, a pull-back year like this should be expected. This is why we invest with a longer-term mindset and as we always try to emphasize in these letters, we encourage you to think and act the same way with your investment account. This means that you can improve your financial situation by consistently saving & investing more cash when you are able to, and by not panicking and looking to sell when investments inevitably decline. In the SFM Quarterly Chart on the following page we show the benefit of this long-term mindset and the monetary reward that comes with it through the long-term growth of your investment portfolio. Often emotions such as fear can tell you to act differently, but focusing on the long-term helps to avoid an overreaction to the short-term movements in your account…meaning it helps to keep your emotions in check and not to focus too much on potential daily and even annual declines. The reason why this is so important is because often only a handful of days out of the year drive the vast majority of the investment performance, and so continuing to stay the course and stay invested makes a huge difference in your investment returns. For example, in 2022 the 5 worst trading days made up 95% of all of the declines in the US stock market…and this concentrated performance also happens on the way back up with the majority of gains happening in just a few days (and you don’t want to be out of the investment markets during these days).

As always, we appreciate the continued trust you place in us, and we welcome any thoughts or comments that you have.

Chris, Glenn, Sam, David, and Molly