Solomon said, “When an evil man reigns, the people groan.” We all understand how this works. In 2022, the American people groaned in many ways, but one of the loudest groans was heard in the financial markets, where nearly every asset class suffered large losses.
Falling markets are a clearer sign of pessimism about the country’s direction than the usual political and economic grumbling. Falling markets speak more truth than angry tirades at family holiday celebrations, howls of outrage on social media, or answers from pollsters about whether America is going down the wrong path or the right one.
That’s because no “expert” seems to face negative consequences for last year’s wrong prediction about America’s future or for sharing foolish opinions with pollsters. Have you ever seen an expert get fired for making a wrong prediction? If that had happened, Cable News would have had to recruit a whole new team in mid-November 2016. But when an investor is wrong about markets and the economy and acts accordingly, he destroys his own wealth. Last year, people “voted” with their investment decisions. The result was an overwhelming vote of no confidence in the country’s economic direction.
It wasn’t just that the markets were falling. A bear market in itself is a somewhat fuzzy signal. As a prankster once said, “Markets have predicted 9 of the last 5 recessions.” Got it? Markets suffer serious slumps more often than actual recessions. Not every bear market portends an actual recession. But the financial groans of 2022 weren’t just a matter of declining markets. It was mostly about which specific markets declined the most. If you decline an offer of mashed potatoes, we know you don’t want mashed potatoes. But we don’t know why until we see what you put on your plate instead. If it’s a salad, then you’ve probably been concerned about the health implications of the potatoes. However, if you ate a fried Twinkie, health concerns probably weren’t the driver.
Looking at investors’ preferences across asset classes, not just what they’ve sold but also bought, tells us what’s really on investors’ minds. Most of the time, they thought collectively of the possibility of a recession. It can be an official recession (two consecutive quarters of negative growth) or a “growth recession” (a period of below-average growth). But either way, fears of growth prevailed. In almost all cases, the value of growth-related assets fell faster than the value of recession hedges. Equities (a riskier asset class) underperformed bonds (which pay a guaranteed fixed income).
Consumer discretionary fell much more sharply than consumer staples within the various stock sectors. Businesses selling vacations, jewelry and fine dining lagged behind those selling diapers, toothpaste and laundry detergent. Consumer discretionary stocks fell more than 35 percent, while consumer staples fell less than 2 percent. When tough times come, luxury buying goes away, but consumers continue to buy the essentials. In a year that saw some top-tier tech funds more than halved, utility investors actually made some money. Fixed income investors clearly showed their preference for the safest of the safe, US Treasuries, over corporate bonds. Pretty much all trading patterns were consistent with the idea of a slowing economy.
And the kind of government bonds that investors liked the most were specialty securities called TIPS (Treasury Inflation Protected Securities). They offer an additional payment at the end of the bond to offset inflation. In other words, even though the Fed took a hard line against inflation, investors were not convinced they would stick to that line. Tax-free municipal bonds were another popular bond class for investors over the past year.
To be clear, pretty much all markets fell, but the ones that fell less, the ones that investors preferred to hold onto were recession hedges, inflation hedges, and tax hedges. That paints a clear picture of what investors think they see on the horizon – higher taxes, lower growth rates and persistent inflation. Your investment decisions reflect exactly what you think.
Talking is cheap compared to actions, such as B. the actual buying and selling. The Bible recognizes this principle: “It is nothing, it is nothing, says the buyer: but when he has gone his way, he boasts.” What people are willing or unwilling to pay says more about what they think than their words. Last year, people with skin in the game said through the market that they were quickly losing faith in America’s direction. That should be a concern of all of us.