Analysts assess that it was a roller coaster ride for investors' last team
The Fed said at the beginning of last year that inflation is not temporary, and prices went up at the fastest rate in four decades. The year-over-year CPI peaked in June at 9.1 per cent and has been steadily declining since then. Many economists have said that the Fed's call about temporary inflation was one of the worst it has ever made.
Quantitative tightening, with which the Fed reduced the size of its balance sheet by $95 billion per month, made things even worse for the financial market participants.
The supply chain problems caused by Covid-19 induced lockdowns in China and the volatility of commodities also put investors in a tight spot.
What had worked in investors' favour in 2021 turned against them in 2022?
If the Fed added money to the system in previous years, it took money out of the system in 2022.
Also, the Fed has raised rates at the fastest rate ever this year. Because of this, the yield on 10-year US treasury bonds went from 1.51 per cent in January to 4.33 per cent in October.
In 2022, the rising cost of money caused the SPX 500 to drop by 19.4 per cent. The Nasdaq 100, most referred to as technology bellwether, fell 33 per cent.
On the other hand, growth stock investors' favourite ETF, ARK Innovation ETF, collapsed by about 67 per cent in 2022.
Most of the time, when interest rates go up, technology and growth stocks get hit the hardest because most of their cash flows happen at a future date. This pulled down their valuations.
In 2022, the markets entered a bear market, a challenging environment for most investors.
When prices fall, it is important to have a well-diversified portfolio that includes stocks, bonds, REITs, commodities, etc. This may appear counterintuitive, given that 2022 was one of the worst years for 60/40 stock/bond portfolios.
However, this might have been one of the rare cases. Also, it's worth noting that such a portfolio would be far safer than one focused solely on growth stocks.
Bonds are considered a haven, and with inflation likely to have peaked, they may rally again as markets price in a recession. Furthermore, diversification does not imply solely purchasing one index.
For example, Apple, Microsoft, Amazon, Alphabet, and Tesla account for more than one-fifth of the total weightage in the SPX 500, indicating that the index is highly concentrated. Diversification could be achieved with an appropriate ETF portfolio.
In 2022, increased volatility was the main challenge for investors.
But then, bear markets tend to be more volatile, and they witness sharp counter-trend rallies also. Market participants should be alert and have a disciplined long-term strategy to avoid getting caught up in short-term trends.
In a bear market, one sector (or more) emerges as the winner. Energy, materials, industrials, and healthcare were among the industries that performed best in 2022.
However, the economy might not continue to do well if it enters a recession. As a result, investors must constantly examine and analyse critical data points.
In conclusion, investors should be passionate about their research and ready to rebalance their portfolios as necessary.
Vijay Valecha is the chief investment officer at Century Financial.