Market Flash - December 2022

2022 ended as one of the worst calendar years on record for investors, with U.S. large cap stocks declining by just over -18% and investment grade bonds sliding by -13%. While equity market declines weren’t necessarily an outlier, bonds were another story. The -13.01% loss for the benchmark Bloomberg Aggregate Bond index was by far its worst annual decline in its history, dating back to 1976, equating to a near 3 standard deviation event.  

Stepping outside of the U.S., investors found some solace in developed markets equities, which declined by just -7% in local terms. However, when we account for the U.S. dollar’s more than 7% rally, that loss widens to -14.45% in USD-terms. The only major asset class (outside of cash) to end the year in the black was commodities. Commodities were one of the very few beneficiaries of the record inflation that weighed on global stock and bond prices throughout much of 2022. 

Equity 

40-year highs in inflation and sharply higher interest rates weighed on U.S. equity prices in 2022, driving the S&P 500 lower by -18.11%. While losses were generally consistent across various market caps, with the Russell 2000 declining by -20.44%, style performance saw much wider dispersion. Large value stocks fell by just -7.54% on the year, compared to a decline of -29.14% for their growth counterparts. This equated to the second largest relative performance advantage for value stocks on record, surpassed only by 2000, where value outpaced growth by more than 29% as the technology bubble burst.  

Last year’s performance differential can be largely attributed to two factors. First, by nature, the value index has much greater exposure to the energy sector. Energy stocks advanced by more than 65% in 2022, as corporate earnings soared along with crude oil prices. Second, high multiple growth stocks tend to have a greater degree of equity duration (i.e., interest rate sensitivity) as investors are paying high prices today for expected future earnings. As rates rise, those earnings, and correspondingly a company’s stock price, are worth less today because they are discounted at a higher interest rate. 

Non-U.S. equities, both developed and emerging, outperformed U.S. stocks in local terms but struggled with the headwind of a meaningfully stronger U.S. dollar. This left developed markets stocks lower by -14.45% in USD-terms, while emerging markets stocks fell by -20.09%. The U.S. style dynamic that we just discussed, also carried over to foreign markets, where many of the same factors were at play. Within developed markets, value stocks declined by just -5.58%, in spite of the dollar appreciating by more than 7%, while EM value stocks declined by -15.88%.  

Fixed Income 

U.S. investment grade bonds fell by -13.01% on the year, as interest rates rose meaningfully across the yield curve. This occurred as the Federal Reserve abandoned their transitory view of inflation, raising the target Fed Funds rate from a lower bound of 0% at the start of the year to 4.25% at their December meeting. Bond yields reacted in turn, with the rate on the 2 year treasury jumping by 376 bps from the start of the year and the yield on the 10 year soaring higher by 225 bps. While shorter-duration bonds provided some protection from rising rates, these sharp increases in such a short amount of time left fixed income investors with nowhere to hide other than cash.  

On a relative basis, high yield corporates and emerging markets local bonds were outperformers on the year, declining by -11.19% and -11.69%, respectively. While this sounds counter-intuitive given the overall decline in risk assets, both benefited from their shorter-duration profile and saw limited impact from spread widening throughout the year, which was generally muted. 

Real Assets 

Outside of cash, broad-basket commodities were one of the few major asset classes to provide investors with a positive return in 2022. Much of the Bloomberg Commodity index’s 16.09% gain, was driven by the broad commodity complex, where prices rose on a combination of renewed post-COVID demand, as well as supply issues created by the Russia-Ukraine conflict. Gold was one of the index’s few major components to end the year in negative territory, declining by -0.74%. Gold prices struggled to keep pace with most of the index’s energy holdings, as sharp increases in safe-haven treasury yields made the precious metal less attractive as a store of value. 

Closed End Funds 

Closed end funds had a generally volatile year, as large swings in equity markets and bond yields caused discounts to see-saw throughout much of 2022. CEFs entered the year trading at some of their tightest aggregate discounts on record, <2% below NAV, before ending the year at more than 7% below NAV. Much of the pain was felt on the fixed income side of the market, where rising interest rates sent bond prices tumbling. The end result was a year-over-year discount widening of more than 700 bps for both municipal and taxable bond funds. On a positive note, this leaves universe-wide discounts nearly 300 bps below the long-term average, which creates opportunities for tactical investors like ourselves. Additionally, we are now seeing yields in excess of 8% for the average closed end fund, compared to a yield-to-worst of 4.68% for the Bloomberg Aggregate Bond index. 

iCM Tactical Strategies 

iCM’s tactical strategies, which utilize ETFs and/or mutual funds, boasted strong performance results across the board in 2022. Our overall fixed income strategy benefitted from both its shorter duration profile, as well as its out-of-benchmark position in emerging markets local debt, which rallied in the latter part of the year as the dollar retreated. Performance for our general equity strategy was supported by sizable overweights to value stocks within U.S. and non-U.S. developed markets, as well as a position in emerging markets value equities. That said, our equity strategy’s largest contributor was an out-of-benchmark position in broad-basket commodities, one of the few risk assets to produce a positive return in 2022.