Finally, we close the books on 2022 which was the worst year for financial markets since the “Great Recession”. The S&P 500, Dow Jones Industrial Average, and the Nasdaq Composite all posted their biggest annual losses since 2008. This also ended a three-year winning streak for the major indices. The writing was on the wall back in November 2021 when the Federal Reserve finally recognized it was time for easy monetary policy to come to an end which it had kept in place for over a decade. Exponentially increasing interest rates, the highest inflation since 1981 and fears of an economic recession were some of the primary causes of this year’s pain.
The cheerleaders of passive indexing have fallen quiet after a decade of yelling that passive indexing is the only way to invest money. As I have stated many times, passive indexing looks great in bull markets. However, it can be a very quick way to destroy capital in bear markets.
The third quarter started with renewed investor optimism but ended with a crushing reminder that the worst is yet to come. The bear market rally that started in mid-June continued through July and into August. However, further signs of sky-high inflation, necessary interest rate hikes, and increasing probability of a “hard landing” and recession in 2023 smashed all hope. Between mid-August and the end of September, the S&P 500 Index dropped almost 17% and closed out the quarter at a new bear market low of 3585.62 (over 100 points below the prior low reached in mid-June).
You may have noticed that the market cycle has changed along with the Fed’s monetary policy shift to fight inflation. With inflation soaring, it is clear that the Fed is way behind the curve on raising interest rates. They will likely stomp on the proverbial breaks in an attempt to rapidly slow the overheated economy and inflation. When the Fed moves into this type of posture, they have caused a recession about three-quarters of the time. And recessions are typically correlated with bear markets.
After briefly touching record highs at the start of the year, markets gave investors a truly wild ride through the first quarter of 2022. Most indices chalked up their first quarterly loss in two years. Any positive sentiment that was carried into the new year got decimated by more sky-high inflation readings, clear indications that monetary policy must tighten faster than expected, and lingering concerns over additional COVID-19 variant surges. As if that wasn’t enough, Russia’s invasion of Ukraine brought a further surge in commodity prices along with huge spikes in market volatility as news and pictures of the horrors of a brutal war sent shockwaves around the globe.