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4Q 2022 Commentary

In what was in no uncertain terms a very challenging year to be involved in traditional investments such as stocks and bonds, we at Proxy Financial were not immune from the markets which plagued 2022.   

Those of you who find yourself reading this, may also have seen our in depth 2022 market synapsis, 3Q2022 Commentary here, however I will recap what I believe to be the most significant drivers of performance for both our strategies at Proxy and the markets at large. 

Inflation, the fear of inflation, and the US Federal Reserve (the fed) were the biggest factors in the resulting bear markets of 2022.  You may have been exposed to some of this through mainstream media, but we will go a bit deeper.  2020, and specifically COVID-19, brought the world to a halt – both socially and economically.  The waves of stimulus which followed, along with the easing and overall loose monetary policies of virtually all governments and banks, allowed for a sharp recovery of the stock markets, housing markets, and most global economies.  The pockets of consumers’ became flush with cash, saving accounts grew more robust than they had been in a decade, and with the world trending back to the (new) normal, people and companies spent. Despite the expected and incidental decreases in laborers (Retirees, turnovers, or those who were better suited on unemployment), the unemployment figures fell to historic lows.  Most people who did return to the work force had new opportunities and the hiring booms across many industries allowed them to demand even higher salaries and benefits (notably in the white-collar sectors). 

Meanwhile, Vaccines were flying off the shelves, COVID was still running rampant, with infection rates skyrocketing, though now with a very low mortality rate, the media pivoted from COVID reporting and the general consensus of the public quickly followed until there were growing sentiments of returning to pre-covid conditions. People began traveling, making expensive home purchases utilizing rock bottom mortgage rates, overpaying for 2016 Honda CRVs, day trading crypto, NFTs, SPACs – life was good!    

So… what happened…?  I don’t need to retell the myth of Icarus or quote the famous idiom for which it brought about, but hubris was involved and society at large ignored the warning signs and the increasing heat.  

Fast forward to 2022 which gave way to the combined compounding effects of strained supply chains (low availability of goods) with an increasing demand. The unfortunate reality remained that the world economies and general production were shut down almost completely for up until then, creating a very large conflict with the above mentioned supply and demand expectations. The cost of housing begun to correct the other way, with both home prices and rent being driven up by new demand and low inventory. Due to international conditions, the previously cheap gas prices quickly transitioned into the most expensive fuel costs and conditions in over a decade, with massive demand. The US domestic supply was significantly diminished by the necessary shuttering of many refineries.  Higher fuel costs do not just effect your commute to work or the drive to the grocery store, but every step from production all the way through shipping and delivery. This was further compounded by our reliance on international goods and production partnerships, many of which fared the same if not worse than the US during the two years leading up to 2022. Additionally, Russia’s war in Ukraine added even more global economic pressures on supply chains, with the resulting sanctions heavily impacting the energy industry. 

All of these factors, combined with the spike in fuel costs, growing costs of used cars, housing, and food (the farming industry was not exempted and suffered rising costs of seed and fertilizer), directly lead to rapid inflation. Controlled inflation can be good as a necessary component of the economic cycle, but runaway inflation is trouble and needs to be monitored and manipulated in an effort to keep it in check. Needless to say, we were not prepared to tackle all of those conditions and in the summer of 2022, inflation hit a 40 year high at 8.6% YOY.  The party that was 2021 was officially over. 

Enter the Fed.  When simplified to its basic functions, the duty of the Federal Reserve is to conduct monetary policy with the goal of promoting and maintaining stability in the US economy. High inflation is a threat to that economic stability, and while there is more than one tool that the Fed could use to deal with the issue of inflation, adjusting the target rate, also known as the Fed fund rate, was the one they decided to utilize most heavily.  The objective behind pushing up the Fed fund target is that borrowing money becomes more expensive and more difficult, slowing heightened investing, and allowing the supply chains to recover and bridge the gap between supply and demand. Throughout most of 2022, the Fed leaned hard on this approach, whether that was the best method or not, we saw the target rate leap from 0.25% at the end of 2021 to 4.5% at the close of 2022. Turning up the dial of he Fed Funds target is not meant to have immediate impacts on inflation, rather it takes time for the effects to cycle through the system. We as individuals and business owners have seen this in mortgage rates, credit cards, as well as both business and personal loans.  Ultimately, in making money less accessible while the cost of just about everything else is heightened, households have less excess cash to spend, and businesses stop borrowing capital for growth and/or expansion. Profit margins are also likely to shrink, and the slowing economy often triggers layoffs and rising unemployment.  The approach the Fed had taken may or may not drive a rescission, but either way inflation and the measures used to control it will have taken its toll on the general economic conditions. Heading into 2023 there remains a tremendous amount of uncertainty for the economy and the markets, but keep in mind that just because inflation may trend down to the historic target of (approximately) 2%, the prices of most goods and services will likely remain elevated.

Hopefully the above recap of the 2022 economy has provided some clarity around inflation, the Fed, and the conditions and reciprocal actions that had led us there.  You might still be asking, how has all this effected the stock market, the bond market, and your investments?  

It may not come as a surprise to anyone who has kept up with the financial news cycles, but on average, both Stocks and Bonds were down for the calendar year of 2022.  This is far from common, and we would in fact have to go back all the way to 1969 to experience market conditions where BOTH the bond and stock markets are down simultaneously (they usually show reciprocal trends). Prior to that it has only occurred two other times in the modern era, during 1941 and 1931. As you can see, the trials and tribulations of 2022 are not something we should regularly expect.  

Proxy Portfolios in 2022.  How we did:

The Proxy Core Global Equity portfolio was down on the year, with few places to hide, seeing both domestic and international markets down. Developed and Emerging markets were also both negative on the year.  The year-end performance for this model was -16.6%, though outperforming (on the downside) both the S&P 500 (-18.13%) and the World index (-17.96).   From a top-down perspective, we made the decision to maintain an overweighting in US equities, however, in anticipation of a shift away from risk, we did transition from a growth tilt toward a value tilt, which proved to be helpful.  Our concern about a down turn or correction in 2022 also lead us to increase our strategic cash position and gold exposure, in order to maintain purchasing power and provide a safe hedge. Those moves also proved to be positive contributors to the total return of the portfolio. Additionally, we made a few tactical adjustments throughout the year. The global energy ETF we added helped to offset losses, and were able to successfully hedge by utilizing a shift from some of our emerging markets position into more developed Europe, who were quicker to recover. Towards the end of 2022 we had also begun to further explore our exposure in the small cap growth space in the hopes of fully capturing any early session rallies in early 2023. The outcome for that move has yet to be determined. 

Proxy Dividend Income had a relatively strong year.  This value focused, dividend-oriented strategy was well positioned for the down turn we experienced in 2022.  The year end performance was -6.6%, outperforming the S&P 500 (-18.13) by over 11.5%.  The key to the success in a difficult equity market was simply sticking to the core investment objective of purchasing the stocks of companies with consistent cash flow that also had a consistent track record of paying out and growing dividends.  The yield at year end was just above 4.3%, rewarding investors who looked to generate income.  One of the key contributors to performance was our exposure to energy. The energy sector was up over 65% and was one of only two positively performing sectors for the year. The other sector, up only 1.5%, was Utilities, which accounts for roughly 10% of the portfolio.  The largest industry detractors came from Communication services (companies like Verizon), as well as Real Estate (IIPR).  While we did not make any big changes to the portfolio, we did take the opportunity to add a few new names that we view as good long term value investments that also distribute very strong dividends. 

Proxy Growth Portfolio, our most aggressive strategy, focused on companies with long term growth initiatives, was the least performing of our portfolios and the only one that underperformed the major equity benchmarks.  Down -38.1% on the year we underperformed the NASDAQ (-32.5%) and the S&P 500 (-18.13). The Proxy Growth portfolio found little refuge from the beating that growth oriented companies took as the market shifted away from risk and the more traditional growth sectors. The combination of many growth stocks trading at a relative premium (after 3 years of very strong returns), and fear that high inflation would erode the future earning of high growth stocks, drove investors far from the start ups and the new technologies that had previously driven investor excitement and investment focus. The two sectors contributing to the gap in performance were Information Technology and Consumer Discretionary, which account for over 50% of the portfolio. With few bright sports to point to in 2022, the portfolio management team did add a few new companies they believe have great upside over the next few years. With 7% in strategic cash reserve still available to deploy in 2023, the buying opportunities in growth remain vast.  Its hard to say exactly when inflation will no longer be a concern and that the economy will be stable enough, but we believe that being early in growth can be very rewarding if you have the patience and time on your side – something our growth clients were rewarded with during the market recovery in 2020. 

Proxy’s fixed income portfolio continued to hold up better than the broad indexes of the 4th Quarter, and on the year overall.  The adjustments we made early in the year to limit average duration remained impactful throughout the entire year. The Proxy Core Fixed Income Portfolio was down roughly -9.18% and the Proxy Low Duration strategy similarly saw a -5.53% drop. While negative numbers like those might seem unappealing during normal fixed income markets, this is seen as a significant improvement (on the down side) to the Barclay’s Agg Bond Index, which was down over -13% for the year. Why this happened is fairly simple – there is a negative correlation between bond prices and rising interest rates.  When rates go up, there is less demand for existing (not newly issued) bonds, and the market value of those bonds goes down. In 2022 the Fed didn’t just raise rates, they boosted them, from a target rate of 0.25% end of year 2021, to 4.5% in 2022.  And they are likely not finished. The silver lining in all this is that this unique credit market has created a rare opportunity for those seeking lower risk fixed income, with a higher potential for long term returns. Not only are newly issued bonds averaging the highest target rate in recent memory, but there is a more immediate opportunity within existing inventory, meaning we do not have to wait for purchasing opportunities.  Bonds are trading at a significant discount; particularly quality government, corporates, and municipal bonds (the only thing better then more income, is more tax-free income). 

Proxy Financial prides itself on its holistic investment management philosophies, and while we discuss the performance of each of our individual strategies separately, due to our blended investment approach, and the impact of investment timing, there are almost never two identical blended returns or asset allocations. Each portfolio that we create is fully customized in order to meet each of our clients unique perspectives, needs, and goals.  We are proud to serve clients both domestic and international and are equipped with a seasoned team of professionals to guide individuals, families, and businesses through all markets.

Disclaimer: Investing in financial markets carries risk, including loss of principal. You can lose some or all of the money that is invested. Past performance is no guarantee of future results. The material contained herein is for informational purposes only. This document does not constitute a recommendation of securities, securities portfolio, transactions or investment strategies. The projections were created based on hypothetical information, there is no guarantee that any of them will come true. Proxy Financial is a registered investment adviser. Proxy and its Financial Advisors are not licensed in all states to offer securities and insurance products. This site is not a solicitation of interest in any of these products or service in any state which the registered representative is not properly licenses.