In anticipation of our 10 for ’23, we look back and grade our forecasts from last year and note where we were spot-on, where we were off-base and where unforeseen wildcards changed the year’s course. 2022 saw a continuation of macro, market and policy uncertainty, which has characterized the post-Covid era. Our best call? That inflation would be at the epicenter of uncertainty, and would crush the performance of the traditional 60/40 portfolio.
1. Inflation
Inflation will dominate headlines for much of 2022, and will pose the single biggest challenge to the economy, investors and policymakers. Wages are persistently higher in the face of a labor shortage and are driving up the cost of goods and services. Owners’ equivalent rent is likely to rise as rents continue to increase.
Score
A
Our inflation call hit the mark: 2022 was a painful reminder of why everyone hates inflation. It eats into savings, wages and investment returns, all of which were eroded by inflation which peaked at 9.1% year over year in June, the highest since 1982. The topography of inflation shifted throughout the year, with prices for goods inflation easing in the second half of the year, as supply chain pressures subsided. Services inflation, however, accelerated into the end of the year as rents—a “sticky” kind of inflation—jumped to 6.9% y/y.
Score
A
Our inflation call hit the mark: 2022 was a painful reminder of why everyone hates inflation. It eats into savings, wages and investment returns, all of which were eroded by inflation which peaked at 9.1% year over year in June, the highest since 1982. The topography of inflation shifted throughout the year, with prices for goods inflation easing in the second half of the year, as supply chain pressures subsided. Services inflation, however, accelerated into the end of the year as rents—a “sticky” kind of inflation—jumped to 6.9% y/y.
2. Households still driving growth, with ample fuel in the tank
The outlook for consumption remains healthy but will moderate. Spending in 2022 will be bolstered by strong wages, significant savings reserves and ample leverage capacity as home prices surge. However, we expect inflation to temper consumer confidence over the course of the year.
Score
A
Consumer spending provided positive momentum for growth in 2022, as expected. In the first half, household consumption rose 1.3% and 2.0% q/q in Q1 and Q2, even as real GDP contracted –1.6% and –0.6%, respectively. Going into the end of the year, consumer resilience remains striking, fueled by all the factors we listed. The University of Michigan Consumer Sentiment survey plumbed fresh lows in 2022, reinforcing that inflation remains a thorn in the side of household budgets.
Score
A
Consumer spending provided positive momentum for growth in 2022, as expected. In the first half, household consumption rose 1.3% and 2.0% q/q in Q1 and Q2, even as real GDP contracted –1.6% and –0.6%, respectively. Going into the end of the year, consumer resilience remains striking, fueled by all the factors we listed. The University of Michigan Consumer Sentiment survey plumbed fresh lows in 2022, reinforcing that inflation remains a thorn in the side of household budgets.
3. Look beyond the unemployment rate
The labor force will likely remain red-hot in 2022, as the demand for workers runs up against demographics and a gradual (and only partial) recovery in labor force participation. This likely means upward pressure on wages will continue.
Score
A
We were spot on here, as the economy added 4.1 million jobs in the first 10 months of 2022, and the unemployment rate hit 3.5%, matching the pre-COVID low. Wages as measured by the Atlanta Fed wage tracker have surged as high as 6.7% y/y, a big gain that still lagged inflation. While wages are off the high as the year winds down, they remain far above the Fed’s comfort level, and remain a problem for corporations as they try to manage costs as growth remains lackluster.
Score
A
We were spot on here, as the economy added 4.1 million jobs in the first 10 months of 2022, and the unemployment rate hit 3.5%, matching the pre-COVID low. Wages as measured by the Atlanta Fed wage tracker have surged as high as 6.7% y/y, a big gain that still lagged inflation. While wages are off the high as the year winds down, they remain far above the Fed’s comfort level, and remain a problem for corporations as they try to manage costs as growth remains lackluster.
4. China: Slower growth may call for strong policy support
China has signaled the start of a monetary easing cycle, in contrast to other major central banks. Looking ahead, a challenge to China’s economy could be slower U.S. growth, meaning a greater reliance on domestic demand. One wild card in 2022 could be China’s management of the COVID-19 pandemic, and its zero tolerance for cases, which is likely not sustainable in the long run.
Score
A-
Policy was a mixed bag. While the People’s Bank of China (PBoC) did pass supportive monetary policy (reduced reserve requirements, cut prime rates and lowered mortgage rates for first-time home buyers), the government maintained strict COVID-related shutdowns and continued to crack down on tech and property sectors that hampered growth.
Score
A-
Policy was a mixed bag. While the People’s Bank of China (PBoC) did pass supportive monetary policy (reduced reserve requirements, cut prime rates and lowered mortgage rates for first-time home buyers), the government maintained strict COVID-related shutdowns and continued to crack down on tech and property sectors that hampered growth.
5. Myth busting interest rate reaction to a Fed tightening cycle
Monetary policy will look completely different in 2022, as the Fed rapidly tapers the emergency quantitative easing put in place during the pandemic and embarks on a rate hike cycle. However, the impact on long-term rates could be muted as long-term growth concerns offset the upward pressure from Fed rate hikes. We expect long-term interest rates to remain near historic lows, with the possibility of moving to 2.00%–2.50% toward year-end.
Score
D
Monetary policy shattered the precedent of the past 30 years with the most aggressive rate hike cycle since the 1980s. At the start of the year, the Fed was expected to raise rates a total of 75 basis points. At time of writing, the Fed has instead delivered four 75 bps rate hikes for a total of 375 bps so far, with another 125 bps expected by the middle of next year. Our expectation that long-term rates would remain below 2% for much of the year proved wrong, as the 10-year Treasury rose as high as 4.25% in October of this year.
Score
D
Monetary policy shattered the precedent of the past 30 years with the most aggressive rate hike cycle since the 1980s. At the start of the year, the Fed was expected to raise rates a total of 75 basis points. At time of writing, the Fed has instead delivered four 75 bps rate hikes for a total of 375 bps so far, with another 125 bps expected by the middle of next year. Our expectation that long-term rates would remain below 2% for much of the year proved wrong, as the 10-year Treasury rose as high as 4.25% in October of this year.
6. Energy: Transition brings opportunity
Energy valuations appear attractive to start the year, with the energy sector being the only sector in the S&P 500 trading cheaper than its historical average. The shift to renewables could promote sector winners as prices remain elevated in the face of constrained supply.
Score
B+
We were right that the energy sector presented a good opportunity at the start of 2022, but did not foresee the black swan event of Russia invading Ukraine, which had enormous implications for investors. While the long-run implications of the transition to green energy remain in place, higher gas and oil prices in 2022 caused the energy sector to surge 72% year to date, by far the best performing sector within the S&P 500.
Score
B+
We were right that the energy sector presented a good opportunity at the start of 2022, but did not foresee the black swan event of Russia invading Ukraine, which had enormous implications for investors. While the long-run implications of the transition to green energy remain in place, higher gas and oil prices in 2022 caused the energy sector to surge 72% year to date, by far the best performing sector within the S&P 500.
7. The institutionalization of crypto continues
Cryptocurrencies will continue to be a focus in 2022, as the size of the market grows and institutionalization of the asset class will become more entrenched. While its correlation to traditional assets must be watched closely, we continue to view it as an intriguing space for diversification and growth.
Score
C-
While cryptocurrencies continued to be a focal point in 2022, it was not for the optimistic reasons forecasted at the start of the year. Even outside of recent crypto-related bankruptcies, from an investment standpoint, bitcoin traded in line with risk assets and failed to deliver diversification.
Looking ahead, we see a delay in institutionalization versus a derailment, as regulatory agencies wrestle with how to treat the asset class.
Score
C-
Cryptocurrencies will continue to be a focus in 2022, as the size of the market grows and institutionalization of the asset class will become more entrenched. While its correlation to traditional assets must be watched closely, we continue to view it as an intriguing space for diversification and growth.
8. Equities: Valuations could test U.S. outperformance
We believe that emerging markets (EM) and other developed markets could close the performance gap versus the U.S. in 2022, given the historically high valuation premium for U.S. stocks and tailwinds for growth in places like Europe and EM.
Score
B-
This call was disrupted by the Russia-Ukraine war that sparked an energy crisis and sent the European economy reeling, and China’s Zero-COVID policy that hamstrung EM returns. While European and EM stocks outside of China have indeed outperformed their U.S. peers year to date on a local currency basis, the combination of an aggressive Fed rate hike cycle and geopolitical instability caused the dollar to strengthen sharply and dented foreign returns for U.S. investors. Ultimately, these valuation gaps actually widened during 2022.
Score
B-
This call was disrupted by the Russia-Ukraine war that sparked an energy crisis and sent the European economy reeling, and China’s Zero-COVID policy that hamstrung EM returns. While European and EM stocks outside of China have indeed outperformed their U.S. peers year to date on a local currency basis, the combination of an aggressive Fed rate hike cycle and geopolitical instability caused the dollar to strengthen sharply and dented foreign returns for U.S. investors. Ultimately, these valuation gaps actually widened during 2022.
9. Macro fundamentals support narrow credit spreads in 2022
While we could see modest spread widening over next year, we believe economic growth, strong fundamentals and low default rates will support relatively tight spreads throughout 2022. We maintain conviction that spreads in the high yield market will average below 350 bps next year and below 400 bps for loans.
Score
B
If we’re being honest, the B might be a little generous. Our conviction that credit fundamentals would remain solid was accurate. Strong nominal growth has led to solid revenue and EBITDA figures, corporate leverage is near all-time lows, interest coverage ratios are at all-time highs and default activity has remained benign. We were correct in our assertion that this backdrop would keep spreads relatively maintained—loans and bonds saw peak spread widening of 238 bps and 275 bps, respectively—but we certainly failed to predict the carnage inflicted on credit prices this year in the face of rising interest rates.
Score
B
If we’re being honest, the B might be a little generous. Our conviction that credit fundamentals would remain solid was accurate. Strong nominal growth has led to solid revenue and EBITDA figures, corporate leverage is near all-time lows, interest coverage ratios are at all-time highs and default activity has remained benign. We were correct in our assertion that this backdrop would keep spreads relatively maintained—loans and bonds saw peak spread widening of 238 bps and 275 bps, respectively—but we certainly failed to predict the carnage inflicted on credit prices this year in the face of rising interest rates.
10. Higher inflation has come for the 60/40
Inflation has shattered its 25-year range, and for investors, even moderate inflation can negatively impact both the fixed income and equity allocations of a portfolio. In 2022, it should be a priority to recalibrate portfolios with the implications of higher inflation in mind.
Score
A+
We were right to be pessimistic about the 60/40 heading into 2022. This traditional portfolio was crushed, with equities down -16% and bonds down -14% YTD. Amplifying the pain was the lack of diversification, as correlation between stocks and bonds was the highest in over a decade. The 60/40 portfolio experienced its worst year in U.S. history driven by inflation and rising rates. The outlook for inflation has improved somewhat in 2023, but remains highly uncertain, and investors should continue to rethink the role of alternatives in adding growth, income and diversification in a portfolio.
Score
A+
We were right to be pessimistic about the 60/40 heading into 2022. This traditional portfolio was crushed, with equities down -16% and bonds down -14% YTD. Amplifying the pain was the lack of diversification, as correlation between stocks and bonds was the highest in over a decade. The 60/40 portfolio experienced its worst year in U.S. history driven by inflation and rising rates. The outlook for inflation has improved somewhat in 2023, but remains highly uncertain, and investors should continue to rethink the role of alternatives in adding growth, income and diversification in a portfolio.
