A Look Back at 2022 and Some of The Noteworthy Market Dynamics

It goes without saying that 2022 was a very interesting year for financial markets and one that will not be forgotten. Both stocks and bonds were down double digits in the same year for the first time ever. While stocks experienced one of their worst years ever, the Bloomberg Aggregate index experienced its steepest drawdown ever. Investors faced a war in Ukraine, the Federal Reserve (Fed) increased interest rates at its steepest pace in four decades, inflation spiked to 40-year highs and mortgage rates more than doubled.

Here are some of the noteworthy market dynamics that played out during the tumultuous 2022.

Lets start at a macro level. The S&P 500 index fell a -18.11%, which was the worst year for equities since 2008 and the Great Financial Crisis when the broad index fell a -37%. Taking it a step further, it was the seventh worst year going back to 1931 and the great depression. If that isn’t sobering enough, look at the number of negative trading days in 2022, the S&P 500 index experienced 143 negative days in 2022 compared to 125 negative days during the Great Financial Crisis in 2008. Furthermore, the 143 negative trading days were the most since 1974 (Source: Zephyr StyleADVISOR). Typically when equities fall so steeply investors are able to find some solace in bonds, but that wasn’t the case in 2022. The Bloomberg U.S. Aggregate index fell -13%, marking its worst annual return since its inception in 1978. The next worst year for the bond index was in 1994 when it experienced a paltry -2.92% return. Futhermore, its drawdown of -17% was its largest ever. This was the worst year on record for the investment grade bond index. Meanwhile, the supposedly safe U.S. Treasuries plummeted as interest rates climbed from historically low levels, resulting in the Bloomberg 7 – 10 Year Treasury index falling a -14.89%.

Source: Zephyr

This dynamic of falling equity and bond prices resulted in a spike in correlation between the two. The  12-month correlation between the two spiked to .76 in September which was the highest since the end of 1997. This increase in correlations between the two primary asset classes really hindered the performance of the 60/40 portfolio.

Source: Zephyr

The 60/40 portfolio fell 16% during the year which was its steepest annual decline since the GFC in 2008, and its second largest decline since 1980. It’s no wonder there were calls saying the 60/40 portfolio was dead. Which I believe was premature and I have said in my 2023 outlook piece that the 60/40 will make a comeback in large part due to opportunites in fixed income.

Source: Zephyr

Getting more granular. Lets take a look at the popular growth vs value performance. The value style outperformed the growth style by over 20% during the year which was its largest outperformance since the dotcom bubble. While growth has benefited from falling interest rates over the past 20 years, value took advantage of the spike in interest rates in 2022.

Source: Zephyr

Alright time to take a look at the ongoing popular debate between active vs passive management. Conventional thinking is that active managers outperform during times of heightened volatility, which hasn’t always been the case. While passive managers tend to outperform when markets are trending higher with lower volatility, or the tide is raising all boats. Well, 2022 was a good year for active managers as a very large percentage of active managers outperformed their respective benchmark during the year across the value and blend styles regardless of the size. Roughly 80% of all mid-cap value, small cap value and small blend active managers beat their respective benchmarks. While 70% of all large value, large blend and mid-cap blend managers beat their benchmarks. Meanwhile, active growth managers struggled to beat their respective benchmark during the year despite a very tough year for the style. Only about 35% of large growth, mid-cap growth and small cap growth managers beat their benchmark in 2022.

Source: Zephyr

Another interesting dynamic played out when comparing large caps and small caps. When comparing the basic Russell 1000 index vs the Russell 2000 index, large caps (Russell 1000 index) outperformed small caps (Russell 2000 index) by roughly 1.3% during the year. When you consider the risk-off environment due to the heightened uncertainty, high inflation, and rising interest rates, it might be a surprise the riskier small caps held their own against the perceived safer large caps. Taking it a step further is even more interesting. When comparing mega-caps (Russell Top 50 index) vs micro-caps (Russell Microcap index), the very small micro-caps outperformed the 50 largest stocks by over 2%. On the surface that may be a surprise considering the high volatility and how risky those micro stocks are. However, when you dig deeper, the top 50 names have a high representation of big tech names, which really struggled in 2022. While small cap indexes have a higher representation of fincial stocks or value stocks which outperformed. So the outperformance by the smallest stocks compared to the largest stocks shouldn’t be that big of a surprise.

Source: Zephyr

As for the top performaing asset classes. No surprise here that commodities was the best performing asset class with a return of 17.5%, while cash came in second with a 1.4% return and was the only other asset class in positive territory. The worst asset classes in terms of performance in 2022 were REITS with a -26% return and Emerging Markets with a -20.6%. Even TIPS, which you would think would perform ok considering the 40-year high inflation, fell a -12%.

Source: Zephyr

As for equity sectors, not much of a surprise here as there were only two S&P 500 sectors that finished the year in positive territory. With the energy sector, represented by the S&P 500 Energy sector index, posting a 65% return and the utilities sector posting a 1.5% return. Meanwhile, the worst performing sector was communication services which fell nearly -40% followed up by the consumer discretionary sector which fell a -37%. The popular information technology sector fell over -28%.

Source: Zephyr

I always like to compare the performance of the equal weighted S&P 500 index vs the cap weighted S&P 500 index, which is the version that is typically used to measure the U.S. stock market. While the cap weighted version is the most popular, it can often be skewed due to a high weighting of the top ten holdings, which recently has been made up of mega-cap tech stocks. One could argue the high concentration in the top ten holdings doesn’t make for a very diversified index. The equal weighted version of the index outperformed the more popular cap weighted version by 6.6% during the year.  Again, this highlights the difficulties the mega-cap tech names had in 2022 as that very popular tech trade during the early stages of the pandemic unwound.

Source: Zephyr

Another interesting performance dynamic that caught my attention was the performance of the different equity factors. The value and dividend factors were the best performaing factors as the MSCI USA Value index fell a -6.2% while the MSCI USA Dividend tilt factor index fell a -7.67%. Those shouldn’t be much of a surprise as consistent dividend paying stocks tend to be more resilient during a market sell-off. What did come as a surprise was the performance of the quality factor. The MSCI USA Quality index was the worst performaing factor during 2022 with a -22.67% return. One would think during times of uncertainty and a steep market sell-off high quality stocks and funds should be able to withstand the volatility. That wasn’t the case in 2022.

Source: Zephyr

It is clear that 2022 was a very noteworthy year for numerous reasons and in the future market pundits and strategists will compare future years to 2022. It’s never good when a statement starts with, was the worst year since 2022.


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