If 2022 Seemed Like The Worst Year Since 536 A.D., You’re Not Alone

Not many will be sorry to see the door close on the past year. Besides being the worst year for stocks since 2008 with the S&P 500 down over 18%, it was also the worst year for bonds in decades—making it one of the very worst years ever for a balanced portfolio (the Vanguard Balanced Index Fund with an allocation of 60% stocks and 40% bonds was down nearly 17%). This perfect storm was caused by the highest inflation rate since the 1980s. Many bubbles burst spectacularly, including those of crypto, meme stocks, and speculative technology. Even so-called “blue chip” tech stocks like AppleAAPL
were hammered, as their price-to-earnings multiples were too high to withstand elevated rates. In some ways, it was the market equivalent of 536 A.D., supposedly the worst year to be alive on the planet. In that year, a volcanic eruption in Iceland plunged much of the world into darkness for 18 months, causing the coldest period in 2000 years of history. Crops withered, leading to a horrific famine, overwhelming human death, hardship, and misery.

The good news is that we don’t live in 536 A.D. (although it often feels that way) and that the Fed, despite a slow beginning, has been quick and aggressive in combating inflation. The Fed funds target rate range now sits at 4.25–4.50%, exponentially higher than the zero rate the Fed had maintained during the pandemic. As I’ve said before, this is not your father’s Fed. The Fed of the ‘70s was led by Arthur Burns, who was weak-willed when it came to fighting inflation. In contrast, Jerome Powell, the current Fed chair, has learned from those mistakes and is risking a recession to make sure that inflation goes back into the bottle. Showing that the Fed’s actions are starting to take effect, inflation has moderated over the past few months—not as quickly as anyone would like, but fast enough to vindicate the Fed’s actions. The bulk of rate hikes (and bond losses) are likely behind us. Though many expect the Fed funds rate to eventually reach 5.25%–5.50%, it would be surprising if rates didn’t start to plateau at that point. If so, 2023 could be a reasonably good year for both stocks and bonds.

A recession is likely. By some measures we already had one in 2022, and could have a double dip this year. But rarely has a recession been so forecast by the media, by markets, and by pundits worldwide. Thus, recession expectations are already largely priced into stocks. It’s doubtful, however, that the Fed will achieve its goal of a so-called “soft landing,” whereby price stability is restored while growth is maintained. Historically, soft landings are rare and recessions are often the price for getting inflation back to its historical average.

Aside from economic gyrations and market tumult, 2022 witnessed a quieter seachange: a shift from growth investing back to our style of investing, known as value investing. Growth investing (which had strongly outperformed for several years and which invests in stocks with high growth rates—on the premise that their outsized growth will continue indefinitely) met its match in higher interest rates and fell out of favor. The Vanguard Growth Index was down more than 33%. Value investing, which recognizes the economic reality that every business eventually reverts to intrinsic value, suffered losses—but much less by comparison. Cycles of value outperformance typically last at least five to seven years. More to the point, value investing has been a much more successful strategy than growth investing over all of our lifetimes. Value stocks have trounced growth stocks over the past hundred years. It’s no surprise, then, that the world’s greatest investor, Warren Buffett, has always followed a value approach. Value cycles can often last over seven years, so it could serve investors well to keep a value orientation for the foreseeable future. Even if you don’t want to commit to value investing for a lifetime, you would be ill-served to ignore it over the next several years.