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Executive Summary

Asset classes of all types fell last year, leaving a traditional “buy-and-hold balanced portfolio” consisting of 60% S&P 500 and 40% cash and Treasuries, down about 17%. However, the declines were not straight down as evidenced by the S&P 500 (first graph below showing bear market rallies). The second graph shows the 2022 price predictions – note all were wrong and overly optimistic. Markets are still overvalued as shown in the third graph, despite the 2022 declines. The current bear market should continue in 2023. Falling corporate earnings should result in falling stock prices. In a weakening economy, bonds represent a safe haven and thus should rise. Of course, a Federal Reserve “pivot” or government stimulus or policy change could change things quickly. Be prepared for an interesting 2023!

Please continue to The Details for more of my analysis.

“There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.”
–John Kenneth Galbraith

The Details

Many investors are probably looking back at 2022 and saying, “Good riddance!” Markets of all types fell last year, leaving a “buy-and-hold balanced portfolio” consisting of 60% S&P 500 and 40% cash and Treasuries, down about 17%. [Note: At Prudent Financial we do not employ a “buy-and-hold” approach.] Breaking down returns on a number of asset classes for 2022:  the S&P 500 Index was down 19.4%, the Nasdaq Index was down 33.1%, and the MSCI EAFE Index (Europe, Australasia -not a typo-, and the Far East) was down around 16%. Even safe haven assets were down, albeit only slightly for gold, down 0.4%. The yield on the 10-year Treasury Note rose 157%, ending the year at 3.88%. Since bond prices have an inverse relationship with yields, the price of the 10-year Note plummeted. The 7-10 year Treasury exchange traded fund, symbol IEF, was down 15.2% for the year, while the long-term (10+ years) Treasury fund SPTL fell over 29%. Lower rated corporate bonds provide higher yields but trade more like stocks due to the higher risk of default. The high yield (junk bond) fund, JNK, fell 12.2%.

As shown in the graph below, the drop in the S&P 500 was not a straight line. There were numerous bear market rallies (circled in yellow). These rallies often convince perma-bull investors that the bear market is over, and they should increase their allocation to stocks. However, like in most bear markets, that would have been a mistake in 2022.

As expected, the year began with overly optimistic projections by the “experts.” The chart below, from Forbes, of 2022 S&P 500 predicted ending values, shows the beginning of year optimism. However, not one of the forecasts was near the actual ending value of 3,860.

Investors during 2022 maintained extraordinary restraint, keeping the S&P 500 from falling further, considering the severely weakening economy and falling corporate earnings. By the end of the year, pandemic stimulus funds appear to have dissipated, and consumer debt was soaring. The full impact of such will likely not be felt until mid-year 2023. Usually, the stock market anticipates forthcoming weakness and begins to reflect it through falling stock prices. Since that has not happened yet, 2023 could provide a sell-off worse than seen in 2022.

If this happens, expect Treasury Bonds and Notes to begin to reflect the weakening economy by rising in price as yields fall. Presently, the bear market remains firmly in place. The graph below of the Crestmont Price-to-Earnings Ratio illustrates a stock market still exorbitantly overvalued, even after last year’s nearly 20% drop. The Crestmont P/E is a derivation of the Shiller P/E prepared by Crestmont Research. The Shiller P/E (S&P 500 divided by 10-year inflation adjusted average earnings) was 28.1 at year-end. The long-term median for the Shiller P/E is 15.9. The Crestmont P/E indicates an even more overvalued market, with a reading well over two standard deviations above the mean.

No one knows what 2023 will hold. Barring outside forces, the economy will likely continue to weaken. And corporate earnings will fall reflecting such weakness. The stock market should drop considerably as earnings fall. It is very possible the market drop in 2023 could be greater than that in 2022. Of course, this could change abruptly with a new stimulus plan or a “pivot” to monetary easing. In 2023 it will be important to be flexible and ready to react in the event significant policy changes are enacted. If not, get ready for another roller coaster ride that could end the year lower than the year began.

The S&P 500 Index closed at 3,840, down 0.3% for the week. The yield on the 10-year Treasury Note rose to 3.83%. Oil prices increased to $80 per barrel, and the national average price of gasoline according to AAA climbed to $3.22 per gallon.


© 2021. This material was prepared by Bob Cremerius, CPA/PFS, of Prudent Financial, and does not necessarily represent the views of other presenting parties, nor their affiliates. This information should not be construed as investment, tax or legal advice. Past performance is not indicative of future performance. An index is unmanaged and one cannot invest directly in an index. Actual results, performance or achievements may differ materially from those expressed or implied. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy.

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