This past year has been a memorable one for financial markets. Fixed income investors, outside of Crown, have seen losses unlike any year in recent memory.
It is hard to recall way back to December 31st, 2021, when the 10-year US Treasury note had a yield of 1.51%. It now sits at 3.58% after a peak of 4.33% in October. Think further back to August 2020 when the 10-year had a 0.50% yield.
As a result of Fed tightening monetary policy, inflation soaring to 40-year highs, and a frankly reckless government spending program, the Aggregate US Bond ETF (ticker: AGG) lost 11.3% year to date. Longer maturity investments lost even more: 20-year US Treasuries (TLT) -26.3%, 7–10-year US Treasuries (IEF) -12.9%.
As bond prices dropped with inflation rising, interest rates climbed at the fastest pace in memory as the Fed realized their mistake and began the real battle with inflation.
It was not a big surprise to see equity prices drop as well. The S&P 500 -13.3% YTD is not terrible given the carnage in the Nasdaq and the S&P 500 growth index, which lost -23.5%.
Now what is in store for the future, you may ask?
As we have recently had a 14.5% rally off the October lows, it's hard to envision further gains anytime soon.
According to FactSet, nine of eleven S&P 500 sectors witnessed a decrease in bottom-up EPS for Q4 2022. In other words, earnings estimates are coming down even as stocks rallied.
Inflation looks like it has peaked. However, the Fed is pushing rates towards the 5% zone in 2023. They have stated rates may need to be “higher for longer” to get back to their long-term inflation target of 2%.
Again, quoting FactSet, we have a consensus, calendar year 2023 earnings estimate of $232.52 deriving a current forward P/E ratio of 17.3x, which is below the five-year average of 18.5x. Only energy and utility companies expected higher EPS estimates for Q4 2022.
There is room for optimism and upside. We seem to have passed through the interest rate phase of the bear market decline. We are still 16.5% down from the all-time high of 4,818 registered back on January 4th, 2022.
Is the stock market bottom in? Are long interest rates going higher? Will earnings be higher in 2023? The answers to these questions will dictate market returns in 2023.
We will try to provide a broader framework in our year-end letter.
As this is traditionally "the season to be jolly," markets are likely to be fairly steady into the year end.
We wish you and your families a very happy holiday season and a Merry Christmas!
Doug Coppola - Executive Director & Investment Committee Chairman
Steve Lindgren - Chief Investment Officer & Partner