Monthly Update

The stock market finished a tough year with a tough month. The S&P 500 closed in December down 5.9% and around 20% on the year[1]. The NASDAQ sold off 8.7% to finish the year lower by 33%[2]. The spread between the performance of value and growth stocks continued to favor the former after years with the latter. The S&P 500 Value Index ended December down 4.1% and by just 7.4% on the year[3]. The S&P 500 Growth Index sold off 7.7% in the last month of the year and by 30% for the full year[4]. International markets also outperformed US stocks as the Euro STOXX 600 was down by 3.4% in December and 12.9% on the year[5]. The Nikkei 225 was down by 9.4% in 2022 and the Hang Seng by 15.5%, helped by a late year rally[6].

Bond yields rose to finish the year sharply higher triggered by aggressive Fed rate hikes in response to the fastest rate of inflation in 40 years. The 10-year yield started 2022 at 1.51% only to end at 3.88%[7]. The 2-year yield, tightly tethered to monetary policy with the fed funds rate, rose to 4.43% from .73% at year-end 2021[8]. The interest rate rise was global however as all central banks tightened policy in some fashion. Even the Bank of Japan (“BoJ”) got around to it in December as they widened the band around its yield curve control to 50 basis points from 25 basis points[9]. The dollar amount of negative yielding bonds ended 2022 at ‘just’ $2.4 trillion from almost $11 trillion at the beginning of the year and vs the record peak of $18 trillion in December 2020[10]. Good riddance to negative interest rate policy with the BoJ the last holdout with its deposit rate at -0.10%[11]. I have referred to negative rate policy as the dumbest idea in the history of economics as it is a tax on capital and a lender should always be paid for extending credit.

In December, the Fed slowed the pace of its interest rate hikes to 50 basis points after four meetings in a row of 75 basis points. The European Central Bank, Bank of England and Bank of Canada did the same by each raising rates 50 basis points. The Reserve Bank of Australia raised its benchmark rate by 25 basis points, and we saw more rate hikes elsewhere[12]. Tightening will continue in 2023 but the pace at which it will take place should slow. That said, balance sheet reductions will continue with the Fed, BoE and BoC and start in Q2 under the ECB.

Also, of note in December, was the weakness in the US dollar for a 3rd straight month. After a 17% rally through September that was pretty much driven by the very aggressive rate hiking by the Fed, the slowdown in the pace of hikes and potentially the end of the rate increases, along with continued rate increases elsewhere, has seen an 8% drop in the past three months[13]. This in turn has helped to lift the prices of gold and silver over the past two months as both ended up closing 2022 near where they started.

What to watch for in 2023

As for the equity bear market, I don't know exactly how it progresses from here as the consensus seems to be down in the 1st half and rally in the 2nd half, but the consensus is usually wrong. All I'm confident about is it isn’t over yet. The big financial bubble in sovereign debt and everything in turn priced off that risk free rate, doesn't end with the S&P 500 down just 20%+ off its highs. It doesn't end at 17x multiples. It doesn't end at a price to sales ratio not far from March 2020. It doesn't end without a notable earnings recession. It doesn't end with credit spreads between high yield debt and US Treasuries still this narrow. Typically, it doesn't end until everyone throws in the investing towel not wanting to ever own a stock again. That said, buying stocks in a bear market has been historically the best time to do so as tremendous values are created. 

But it isn't easy reconciling how things play out in 2023. On one hand, I'm worried about the trajectory of economic growth but I also believe the full reopening of China in Q2 will be a huge economic positive. However, one that might mostly be positive for China, the rest of Asia and parts of Europe such as Germany that do huge business with China should also benefit as well. The US doesn't export much there. It will be good for commodities and the countries that produce a lot of them, such as some in South America.

I've expressed my worries many times about the leveraged loan market and all those companies that have exposure to floating rate debt, including many small businesses with their local banks. For reference, the leveraged loan market is about $1.4 trillion in size (not including bank loans given to small businesses), about the same size as the US high yield market[14]. For those with investment grade or high yield debt, the risk isn't as much in 2023 and 2024. Steve Liesman on CNBC last week highlighted in a chart that the massive maturity wall for these two groupings won't be hit until 2025 and 2026. It totals about $1 trillion in 2023, goes to almost $1.4 trillion in 2024 and then more than doubles to $3.25 trillion in 2025 and just above that in the year after[15]. So those that have termed out their debt for the next few years will be much better off than those who didn't or didn't hedge their floating rate exposure. 

Energy will still be a huge issue for Europe as we progress through the year because it will be much harder to refill gas storage going into next winter. The war in Ukraine is not ending anytime soon and the reopening in China I believe should lead to MUCH higher crude oil prices, something north of $125 per barrel. I read last week that according to the International Energy Agency in September, China was on track in 2022 to purchase the smallest amount of oil since 1990. Let that sink in with prices currently still near $80. I will repeat that I believe that oil prices are going to go much higher and I'm not just talking back to $100 and $125. We remain long on energy stocks, particularly European majors that trade at half the multiple of US ones and we also own natural gas stocks. 

Speaking of China, the unleashing of the Chinese consumer and tourist beginning in Q2 I believe will be massive. I don't think people appreciate how important they were pre-Covid and after being essentially locked up for 3 years, having them back will be a huge economic factor. According to UN data, in the 5 years leading into Covid, Chinese tourists spent about $250 billion per year. Just a week ago, according to an Asian-based online travel agency, they said that their sales for travel tickets rose 4x over the previous day. Pre-Covid, according to Bain & Co, the Chinese consumer made up 1/3 of global spending on luxury items vs between 17-19% in 2022. In a Bloomberg story last week, they quote a 26-year-old Shanghai resident who had Covid and said "I can't wait to embrace freedom and make a long-distance trip with my friends. Three years have been wasted. Omicron cannot deter me. I'm so thrilled to be setting off in two weeks' time." Multiply that feeling and action by the many millions. 

I remain bullish on the Asian economies and markets, (particularly India, Singapore, Vietnam and Japan) as a result of China’s reopening, as they are major beneficiaries of not just the Chinese consumer but also a rebound in the overall Chinese economy. According to the WSJ, pre-Covid, about 1/3 of tourists to Japan and South Korea were Chinese. In 2019, about 25% of visitors to Thailand were Chinese as well. In the FT last week, they quote someone from the Shenzhen based head of McKinsey's Asia travel practice who said, "Pre-pandemic, China was the world's largest source of outbound tourists, with 150mm travelers going abroad each year." He forecasts international trips by Chinese travelers would be 50% of 2019 levels by the summer vs 5% just recently. That will eventually get back to 100%.

I am still very much of the belief that longer term bond yields will surprise to the upside even in the face of falling inflation and economic growth, although China's reopening could reverse those two factors. I remain worried about the impact of more ECB rate hikes and quantitative tightening (“QT”). At the same time, we'll likely see more Yield Curve Control (“YCC”) spread widening when Kuroda leaves, and the US budget deficits and debts might FINALLY matter for investors, and the Fed continues with QT. This in turn will lead to a higher 10-year US yield. These regions were the epicenter of the global bond bubble. There are so many more attractive high-quality bonds to buy with maturities no further out than 2-3 yrs. 

Inflation will fall notably this year as the goods price inflation continues to reverse and rent growth continues to slow. We may even see some zero y/o/y prints by year end. BUT, that is NOT where inflation should end up settling out at in 2024 and it could be 3-4% rather than 1-2% for reasons I've stated many times before. Thus, any rate cuts by the Fed in the back half of 2023 will be limited if they happen. Also, if I'm right on oil prices, headline inflation should really get whipped around this year. 

Gold, which had a great year in 2022 relative to just about everything else, I believe will do well in 2023 as the headwinds of a very aggressive Fed and coincident strong dollar should be just about over. 


As we shift the calendar to another year, we unfortunately cannot quickly turn the page on the factors that influenced 2022 as they will carry over into 2023. That said, as stated above, I do believe the attentions will shift but the investing landscape will remain a challenge.

As we continue to navigate through this, it remains vital that investors have adequate short-term liquidity over the next 2-3 years. Knowing that period is covered can help separate the balance of one’s portfolio from what I believe will continue to be a bumpy time for the economy and markets. Time horizon is very crucial right now and is the best friend of any investor. I want to also finish by saying that in bear markets, both in stocks and bonds, tremendous opportunities will be created for those that have cash and the risk appetite to take advantage.

Finally, we wanted to wish you all an amazing 2023 and particularly a healthy one. We are grateful for your trust and confidence in us.


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[1] Bloomberg

[2] Bloomberg

[3] Bloomberg

[4] Bloomberg

[5] Bloomberg

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[7] Bloomberg

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[9] Bloomberg

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[13] Bloomberg

[14] Bloomberg

[15] CNBC 12.29.2022, Squawk Box