Market insights and analysis

By Jason Teed

Inflation was a major concern for the market in 2022. The second and third quarters saw aggressive interest-rate increases in response, sending broad prices crashing. But inflation played a different role in market returns in the fourth quarter. The Federal Reserve’s actions appeared to have started working and inflation began to slow.

The trend of bear market rallies seen all last year resumed in the fourth quarter. The S&P 500 Index rose more than 14% over the first two months of the quarter. However, the Santa Clause rally never appeared, and the Index, along with most other equities, gave back gains in December.

Despite the December drop, the S&P was up 7.6% for the quarter, the Russell 2000 Index was up about 6.2%, and the NASDAQ 100 Index was relatively unchanged. The gains for the quarter were largely due to expectations that the Fed may not have to be as aggressive as anticipated to get inflation under control.

However, the Fed has declared that interest rates will likely remain high for some time to ensure that inflation continues to fall—though rates might not climb as high in 2023 as previously expected. Continued high interest rates could negatively affect equity returns and corporate earnings, as well as lead to a recession. That line of thinking held more sway in December as the market fell. The tug-of-war between inflationary and recessionary pressures will likely continue to affect the equity market going forward.

Cyclical sectors represented both the best and worst performers for the quarter. The best-performing sectors were Energy and Industrials, while Consumer Discretionary and Technology were the worst performers. With such varying performance, some sector-rotation trading strategies were profitable during the quarter. This highlights the importance of active management and strategic diversification, particularly when most asset classes appear to move in tandem.

While equity markets rallied in response to falling inflation, the U.S. dollar did the opposite. Though the dollar had been strongly up for the year, it gave back some of its returns in the fourth quarter, falling about 7.7%. This gave gold the tailwind it lacked earlier in 2022, and it rose 9.8%. Gold’s gain was largely due to a declining dollar and not a safe-haven play. Equities were bullish, and other safe-haven assets, such as long-term Treasurys, were relatively flat for the quarter.

Performance trends for the quarter

Despite the reversal in the year’s prior trends, about 42% of our strategies at Strategic Solutions were profitable for the quarter. Top-performing strategies tended to be either sector-rotation strategies that could navigate the tumult of the equity markets or strategies that were not trend-based.

Trend-following and momentum strategies across the industry struggled in the fourth quarter and throughout 2022, as the market seemed to quickly reverse every time a new trend started. Strategies that traded long-term bonds also faltered after facing a fairly strong reversal in trading patterns in the fourth quarter.

Among our strategies available in multiple risk profiles, the most aggressive risk profiles tended to perform the worst (with a few exceptions), while more conservative risk profiles had better performance.

In times like these, when market reversals are common, the specific investment methodology employed by a strategy can mean the difference between a gain and a loss—even if strategies have similar investment philosophies. Flexible Plan Investments offers portfolio-building tools to help ensure that your investment portfolio is properly diversified to mitigate these risks.

One final note: When investors experience a severe market decline like in 2022, it is important that they retake their Suitability Questionnaire to ascertain whether their attitude toward market risk has changed. To obtain a new Suitability Questionnaire, please contact us or your financial adviser.