Nearly every company in our industry summarizes market movements from the previous month, quarter, and year. The truth is we pay little attention, if any, to these reports. In our view, it’s like driving across country but only focusing on the last 30 miles of the trip. Interesting––maybe––but the snapshot provides little insight on the journey as a whole: where you’ve been, where you’re heading, if you stopped for selfies at “The World’s Biggest Ball of Twine”, or details about arriving at your destination.
Recent market trends are only a snippet of your investment journey. That said, we are still responsible for understanding how the current environment impacts our approach and portfolios. Data collection and awareness are critical. However, it’s imperative to not let recent market events distract us from making wise investment decisions.
With all this in mind, investors faced quite a bit last year:
- 2022 was the 7th worst year on record for equity investors
- It was the worst year on record for bond investors
- Inflation expectations moved from transitory to more persistent
- The Federal Reserve hiked rates to dampen inflation, impacting the profitability outlook of companies industry-wide
- Global markets struggled with Covid’s continued impact on supply chains
In some facet, everyone everywhere felt the pain. Yet we know investors will always face a list of challenges. This is precisely where opportunity lives. Below you’ll find our summary of how the market was impacted as it processed all this information. In addition, a reminder of what drives our decision making and what we’re watching throughout the rest of the year.
2022 In Review
The Fed raised rates seven times in 2022, resulting in an overall increase of 4%. Increasing rates impact the profitability outlook of companies, and certain areas of the equity market were affected by this more than others.
The most significant tremor was felt in two specific areas: technology companies and public
companies classified as “Growth” stocks.
Why Were They Impacted?
Rising rates increase a company’s debt expense and lower revenue expectations as demand slows. The reduced expectation of future cash flow lowers an investor’s expectation of how the company’s stock will perform moving forward.
A Reminder of our Approach
Buttonwood Wealth’s investment approach is based on a belief in markets as explained by professor Eugene Fama’s Nobel prize-winning efficient market hypothesis. From there, we build broadly diversified, low-cost portfolios which own companies that embody specific characteristics that research suggests can help increase your expected return over time.
Many investors are familiar with the Standards & Poor’s 500 index. Below is a graphic known in our industry as a “style box”. It is a nine-square grid that provides a graphical representation of an investment’s style or makeup.
In this example, we use Vanguard’s mutual fund VOO which is designed to track the S&P 500 index.
In the above style box, 38% of the stocks owned in VOO are classified as Large Growth companies. As you can see, there is very little exposure to mid-size companies and no exposure to small companies. Given the definition of the S&P 500 index, this is expected.
By contrast, the style box below represents a sample portfolio: one that is broadly diversified yet specifically targets Value companies, especially those in the small-mid size market:
2022 Equity Sector Returns
We cut out the returns of mid-size companies to simplify this example. In 2022, Value companies held up very well as compared to Growth stocks. Rising rates had a much larger impact on Growth stock valuations, lowering them substantially.
Clearly, one year in the market does not define the journey of your investments over a lifetime. Making rash decisions based on twelve months in the market is reactionary. When you’re tempted to take a shortcut thinking you’ll get there faster, remember there’s a reason you chose to take the scenic view without taking panicky shortcuts.
The takeaway is that not all areas of the market work in tandem. Staying disciplined to an approach grounded in decades of academic research is essential to tuning out the noise of recent market activity.
You are in the right place, right now, for a purpose.
DFA US Large Cap Value (DFLVX). The performance of this fund is being used as a proxy for the Large Cap Value U.S. market. The return data was provided by Morningstar.com. This is not a recommendation or endorsement of this fund. Consult your financial advisor for specific recommendations.
DFA US Small Cap Value (DFSVX). The performance of this fund is being used as a proxy for the Small Cap Value U.S. market. The return data was provided by Morningstar.com. This is not a recommendation or endorsement of this fund. Consult your financial advisor for specific recommendations.
Vanguard Growth Index Admiral (VIGAX). The performance of this fund is being used as a proxy for the Large Cap Growth U.S. market. The return data was provided by Morningstar.com. This is not a recommendation or endorsement of this fund. Consult your financial advisor for specific recommendations.
Vanguard Small Cap Growth Index (VISGX). The performance of this fund is being used as a proxy for the Small Cap Growth U.S. market. The return data was provided by Morningstar.com. This is not a recommendation or endorsement of this fund. Consult your financial advisor for specific recommendations.
There are risks associated with investing in securities, commodities, stocks, bonds, exchange traded funds, mutual funds, and money market funds. These risks included but are not limited to a loss of principal. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained herein constitutes a solicitation, recommendation, endorsement, or offer by Buttonwood Wealth or any third-party service provider to buy or sell any securities or other financial instruments in this or in in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction. All Content herein is information of a general nature and does not address the circumstances of any particular individual or entity.