This stock market report begins with a rebound during the fourth quarter, though the market still ended lower over the year. In the U.S., large company stocks rose 5.9% over the quarter, though lost 18.1% for the year. Small company stocks gained 5.6% over the quarter, and were down 20.4% for the year. Foreign stocks did well for the quarter up 17.8%, though lost 14.5% over the year. Bonds were up 1.6% for the quarter and down 13.0% for the year.
The Federal Reserve began raising interest rates in the U.S. in March 2022 as part of an effort to slow down the economy and thereby rein in a worrying rise in inflation. When the Fed raises interest rates, borrowing money becomes more expensive. This reduces the buying power of U.S. consumers and in turn reduces consumer demand. A drop in demand helps to contain inflation which occurs when too much money is chasing too few goods.
When consumers have less to spend, businesses must reckon with diminished revenues and profitability.
Additionally, borrowing becomes more expensive for businesses themselves. They pay higher rates of interest on their existing loans and tend to borrow less new money which reduces their capacity for financing growth initiatives such as research and development. Consequently, investors begin to anticipate smaller future profits, making stocks less attractive and driving the markets down. The stock market tends to underperform during periods of rising interest rates.
The stock market rose throughout November on indications that the Fed was beginning to make headway on curbing inflation, which suggested that interest rate increases might decelerate. However, by December, data confirmed that the U.S. economy was proving stronger than expected. This could stoke inflation and in turn, prompt the Fed to raise interest rates to even higher levels and hold them there for a longer period.
The market outlook for 2023 hinges on the question of continued Fed rate hikes. The sooner the economy shows meaningful signs of slowing and inflation abates, the sooner the Fed will be able to end the current rate hike cycle. The stock markets may anticipate this shift in advance and could begin a recovery at any juncture in 2023. Though, should a recession materialize in 2023, market turmoil may be prolonged.
Two straight years of losses in the stock markets are rare, though not implausible.
This has occurred only four occasions over the last hundred years in the U.S. It is indeed remarkable the degree to which Fed interest rate tinkering has such a powerful influence on U.S. economic and market prospects. The modern U.S. economy is an enormous and complex enterprise producing some $23 trillion in goods and services in 2021.
This is a far cry from the early “free enterprise” model which was envisioned to function as an effective resource-allocator bringing buyers and sellers together in the marketplace with equal power and equal information. In its early conception, public commerce would inflict no collateral damage on transactional bystanders such as communities, the environment, labor or the domestic harmony, known as “spillover” effects. Though in our modern economy, spillover effects abound.
Public confidence in today’s large corporations of forthright behavior and regard for the public interest runs very low. Indeed, there is a wide swath of collateral damage resulting from an overemphasis on corporate goals prioritizing efficiency and profitability. While these objectives are appropriate for businesses, they have become disproportionate and out of balance with other goals, broadly defined as good corporate citizenship.
This frames our work as socially responsible investors (SRI). Through the consistent engagement and resolve of authentic SRI managers with corporate leadership across all sectors of the U.S. economy, rational Environmental, Social, and Governance (ESG) objectives are becoming a bigger part of corporate decision-making and practices. Pushback from unenlightened corners has begun against our efforts which, the way we see it, demonstrates that progress is happening.
[Correction: The market report erroneously noted that bonds were down in the previous quarter. Bonds were up 1.6% in the last quarter of 2022 and down 13.0% overall for the year.]