Market Update December 2022 – Friends Back Together for the Holidays?
It’s only right to see old friends back together during the holidays. From a pandemic to generous central bank largess, followed up with a war, and all contributing to dangerously rising inflation, three of the major equity indexes have taken different paths to the same outcome.
Against this background, investors are appropriately introspective as they look to the coming year. Sentiment is cautious, a good way to start 2023 and the uncertainties of the time. 2020 experienced this setup starting with a prevailing environment of caution due to the global COVID outbreak. But through late 2020 and into 2021 caution turned toward optimism as central banks pursued loose monetary policy and capital flowed into risk markets, pushing prices higher. To some degree market activity had the characteristics of “did you buy” rather than “what you bought”. But was it optimism? Or was it the math of the time: monetary stimulus + nearly free capital (i.e., near-zero interest rates) = risk taking?
A clue was evident when the tech-heavy NASDAQ Index (CCMP) significantly outperformed the traditional Dow Jones Industrial Average Index (INDU) over the two years of 2020 and 2021 (as seen in the chart below). While INDU was heavily impacted by traditional large cap sectors, CCMP held a good share of “promising” tech-related companies trading at high multiples (as is shown with each indexes Price/Earnings ratio), some of which had yet to establish reliable profitability. Yet, during 2020-2021 CCMP more than doubled the return of INDU, but was priced approximately three times per earnings than INDU. Risk taking? Speculation? Cheap money?
But inflation concerns and rising interest rates soon followed and in 2022 investors shied away from more speculative, high P/E companies, turning towards less “expensive” established areas in the markets. The increased cost of money due to rising rates took its toll on the more speculative members of the capital markets and these three indexes have converged to meet again in late 2022. The general market trend towards consistency and profitability has taken the lead, suggesting speculation has receded. This renewed focus on fundamentals will provide a firmer foundation for the next leg in markets. As economic uncertainty runs its course, we may already be seeing a clue to the next stage with INDU nearly back to its early January highs while CCMP remains down more than 25% from its previous high. But first up is the elusive “soft-landing”. Could the stability represented by INDU be telling us something???
Dow Jones Industrial Index and NASDAQ Composite Converge
S&P 500 Index
January 2020 – November 2022
Chief Investment Officer
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