DIA - 2022: Separate Myth From Reality To Understand How You Did

Summary

• Somewhere along the way toward the liberation of the self-directed investor, some interference arose.
• Specifically, the S&P 500 Index became everyone's benchmark, or so it seems.
• If an investor is willing to see their portfolio swing 40% or more in either direction in a 12-month period, perhaps they are in sync with that concept.
• For the rest of us, risk-management comes first, not chasing a benchmark that probably doesn't apply to the majority of investors.
• 2022 was a great lesson in how to determine what your true investment benchmark is. Here, we present a wide variety of choices to consider.

By Rob Isbitts

2022 was a first for most investors. Stocks and bonds fell together. And in many corners of the market, they fell very hard. That should be a wakeup call for many to consider what their true investment benchmark should be. At the core of that decision is how much of a decline can one take in a specified time period, such as 1 year, 3 years or 5 years.

Long-term investor: are you sure?

Being a "long-term investor" is an admirable goal. But it is quite possible that 2022 ushered in an era in which that phrase must be defined by a different set of guardrails. This article reviews 2022 briefly, and in terms of performance of a wide array of investment market segments. We are certainly not going to tell any investor what their benchmark should be. But we can help by showing self-directed investors how to assess market performance with much wider lens than many may be used to. We'll also conclude with some concrete thoughts about what 2022's manic markets mean for the year ahead. Don't quote us on "this is where the market will be at the end of 2023." We prefer to take things as they come, and we are very process-driven. That process contains many parts, designed to work together by challenging each other from different angles. And if 2022 showed us anything, it is that you have to manage through the market you had, not the one you wish you had. In other words, flexibility and adaptability were the key buzzwords around our place in 2022, and we think that will be the case for a long time. OK, enough with the generalizations, let's examine some data and pictures! Note that all data is through market close on 12/22/22.

The stock market in 2022, and implications for 2023

Here's a look at the path of several widely-known stock market measures. The Dow has held in the best, by far. But look at that pink line, which shows the performance of the "equal weighted" S&P 500. In other words, instead of having FAANG stocks and a few others dominate the performance because they are weighted so heavily, all stocks get an equal weighting of about 0.2% of the S&P 500. In years like this, when the tech sector and Nasdaq 100 stocks lead the market down, that can prevent investors from seeing that there were places to hide, relatively speaking.

This also relates to the benchmarking issue. That is, how you evaluate your own performance, or that of whoever may manage your investments for you. The S&P 500 is the king of representing the "stock market" for so many investors. It was down nearly 20% for the year, including dividends earned. Combined with the Russell 2000 Small Cap market segment producing a similar return, 2022 was a year in which the primary market measure (S&P 500) took on more risk than one might expect. After all, Small Caps are usually riskier than large caps.

The implications for 2023 are many, but one truly stands out to me. That is how much 2022 resembles 2000. Not exactly for sure. But the idea that the Dow, with its lower tech weighting and greater emphasis on more tenured businesses, was the clear outperformer in a generally rough stock market. This is what happened in 2000, and even continued for the first part of 2021. Then, the market declined in sync. And just as in 2022, rallies were sharp and short and frequent along the way. But the bear market did not finally end for good until March of 2003, a full 3 years after it began.

This is top-of-mind for us to watch for an analogous pattern during the first quarter or so of 2023. There are too many similarities in investor behavior and market measures we track (proprietary and otherwise) to take our minds off of that threat to wealth in the year ahead. That also means that if your mission is to "beat the S&P 500" by taking more risk than the S&P 500, either through security selection, leverage or both, think twice before you continue to do so.

Non-US Stocks: Like my mother used to say

My Mom passed away in 2022 after a long battle with Alzheimer's. But while it was a long time since we had a normal conversation, I still recall many of her common expressions since my childhood. One of them was, when my brother and I would misplace something, was "it's always in the last place you look!" That was some Mom humor, long before Dad jokes were a thing. But in 2022, the last place you would normally look for returns in bear market actually produced them. Latin America. As you can see below, it gained double digits here. We don't focus too much on that region of the world in our shop, but for many investors, maybe this will perk up the masses in 2023. We'll see.

The more prominent item on that chart to me is the US Dollar, since it really had a significant impact on world markets during the year. I'll spare the detailed dissection of the Dollar for others on Seeking Alpha who track currencies more deeply than I do. What I can say is that any chance that non-US stocks might have had to reverse years of underperformance versus the US stock market were blunted by the appreciation of the Dollar against world currencies. A basket of such currencies, most prominently the Euro, is what makes up that "Dollar Bullish" ETF shown above.

China took 2022 the hardest among major non-US benchmarks, and for good reason, given extended lockdowns, social unrest and increased investor concerns about geopolitics. The era of cheap goods is likely behind us, and that means China is more likely to be volatile than profitable for extended periods of time. However, it would not be a surprise to us if the market segments that suffered the most erosion in the bear market of 2022 eventually came out of the gate quickly in the next bull market.

But "next bull market" is not in our sights just yet. A deeper decline in the Dollar, which we assign a fair chance of occurring at some point during the next year, would immediately put the spotlight on a big set of market segments that have been essentially left behind for a decade. Namely, nearly every global stock market except the US.

Bonds and commodities

If you benchmark your portfolio to bonds because you have seen them as a long-standing anchor of a retirement income portfolio, our suggestion is to widen your definition of "retirement income." Because in 2022, bonds showed what they have always been capable of, despite many investors not realizing. That is what happens when something avoids a major decline for the entirety of the active investing careers of so many self-driven and professional investors.

Who knew that bonds could fall so much in price? Who knew that there could be no place to hide in stocks or bonds, sans getting creative with tactical trading, shorting market segments (through ETFs, as I often do) or waiting until T-Bills rise enough in yield to take shelter?

While I have a years-long, documented history of writing and time-stamping my secular opinion that bonds would ultimately be the worst investment on the planet (my words), I was never surprised that the vast majority of investors didn't believe me. After all, when something has never happened in your life, much less your investment life, it is hard to imagine it. It was no different before and after the 2008 Great Recession, where people found out that home prices go up more than they go down, but once in a while, they crash. Same with bonds.

So, the bad bond year has come and gone. Now what? This is, to me, a way tougher call than the stock market. Because the bond market is driven by so many factors to begin with. Now, that is compounded by intense volatility in the very part of folks' portfolios that were traditionally more stable in price. I think those days are gone for a while, thanks to Central Banks feeling the need to control things through their words, and the massive presence of algorithmic trading systems that take those words (often out of context or oversimplified) and make prices go "pop and drop" with regularity.

The worst news for bond investors (potentially)

In other words, this is no longer your parents' bond market. Not when you can have 1-3 Year US Treasury Note returns check in with negative returns...in 2 straight years! That's what you see below. They slipped a bit in 2021 and fell further in 2022. And given what I see in the charts for the bond market going forward, there is no "table-pounding" case I can make that the rise in yields (short-term and long-term, high-quality and lower-quality) is over, simply because 2022 is.

My bottom-line on bond investing: learn the new realities, tread carefully, and do not simply get lulled into complacency as stock market investors did, thinking that every dip was a buying opportunity. Bonds are more cagey/volatile than ever, and that has to do in part with systemic reasons, such as vanishing liquidity in some traditionally ultra-liquid markets.

T-Bills: shelter, but for how long?

I have heard investors bragging that they did very well in 2022 because they "went into T-Bills at the start of the year." That was good timing, but make sure you don't hear a tale taller than it actually is. As shown below, T-Bill rates started the year around where money market rates were: zero. By mid-year, 3-Month T-Bills still had a "1-handle" as we say. That is, their yield was over 1% but less than 2%. You couldn't lock in short-term rates above 4% until earlier this calendar quarter. So, they are there now, and might be a nice place to allocate more than you have to that suddenly sexy asset class than you have in years. I did so in my long-tenured "Modern Income" model portfolio, as well as other parts of my personal portfolio.

And, while none of this should be construed as investment advice, you don't need me to tell you that 4% or so in US T-Bills versus the array of risk-filled asset classes is something to completely ignore. There are ETFs that can be used to allocate to T-Bills of varying maturity ranges, and they can be bought directly or through brokerage accounts. All I am saying in regard to short-term US-government-backed securities is this: after about a decade of being a good thing to ignore, they may at least temporarily play a role in portfolios.

Final thoughts (for the moment)

No, you are not going to get me to proclaim some precise estimate of what will happen in 2023. That's for the game-players and gurus. I will simply summarize all of the above by saying this: consider all of the above. And do your homework. Our team is driven to provide as many different ETF profiles as we can get out there to help investors consider a wide array of choices that investment vehicle type provides.

Because using the S&P 500 or a traditional balanced portfolio of stocks and bonds as a benchmark as many did in the past leaves a lot of "meat on the bone." There's a whole wide world of investment market segments, slices and styles out there. Seek to make 2023 the year you expand your purview. We aim to provide as many tools to help investors figure out what we believe is a new era of investing, of which 2022 represented the first salvo. Modern markets require a modern approach, whether to income, capital preservation, growth or all of the above. And fortunately, the ability to be flexible and adaptive as markets gradually proceed through these massive sea changes has never been better!

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