January 2023 update - How bad was 2022 and the outlook for 2023

2022 was an unusually bad year in financial markets. US stocks lost 19%, the most in a calendar year since 2008. Losses in some areas were much deeper. The technology sector dropped 31% and communications services stocks, which includes Alphabet (Google’s parent company) and Meta (Facebook’s parent company) plunged 40%. The Canadian stock market fared better, losing only approximately 5% for the year. Unlike most years, the biggest surprise for investors came from the bond market. Normally, investment-grade bonds tend to hold up when equities go down, reducing risk in a balanced portfolio. However, in 2022, the broad US bond market fell 13% while the Canadian bond market dropped 11%. Long-term bonds did even worse, falling almost 30%. For most categories of investment-grade fixed income, this was the worst year since at least 1980. The reason for this is that central banks rapidly raised interest rates to try to fight inflation, driving them up from near 0% to over 4% in a single year. When interest rates climb, bond prices drop. The good news is that banks are not likely to raise rates much longer in 2023. While inflation is still high, it is at least starting to come down. In Canada, it dropped to 6.3% on the year to December. There will probably be smaller rate hikes in the first half of 2023, possibly up to a level of around 5%, and then there’ll be a pause. So, it is unlikely that bonds will have another year quite as bad, and they will be in their more familiar role of providing stability in your portfolio.

When it comes to stocks, making predictions for this year is particularly difficult, not that it’s ever easy to begin with. Equities have risen so far to start the year because the markets seem to think central banks will go so far as to cut rates later in 2023, but that seems premature. Even though inflation has slowed down, it is still well above the 2% pace that is the target for both the Federal Reserve and the Bank of Canada. However, economic activity is slowing, which is bad for stocks. Home prices in Canada fell 12% in 2022, according to the Canadian Real Estate Association, which is also predicting a tough 2023 for the Canadian real estate sector. In a survey by the Bank of Canada on business outlooks, an increasing proportion of businesses expect their sales to drop this year. In the US, the Conference Board is expecting a recession in 2023. So, prudence is warranted going into the year. However, there is an important difference from 2022. The higher interest rates mean that bonds are now returning a decent yield, whereas before they were paying close to nothing in interest. For the first time in years, you’re finally getting paid to hold fixed income investments. And if equities do head down again because of a recession, bond prices will likely go up. Safety will pay while you wait for better opportunities in the stock market.

Sample portfolio for a Canadian investor

Asset class	ETF ticker	Weight
Canadian stocks	VCN	2.25%
US stocks	VUN	11.25%
Foreign stocks	VIU	9.00%
US corporate bonds	ZSU	0.00%
Canadian corporate bonds	XSH	0.00%
Global high yield bonds	MHYB	0.00%
Emerging markets bonds	ZEF	0.00%
Global real estate	TGRE	2.50%
Canadian mortgage-backed bonds	ZMBS	30.00%
Canadian government bonds	CLF	15.00%
Global government bonds	XGGB	15.00%
Gold	KILO	15.00%

Sample portfolio for a US investor

Asset class	ETF ticker	Weight
US stocks	SCHX	11.25%
Non-US stocks	SCHF	11.25%
US corporate bonds	SPIB	0.00%
Non-US corporate bonds	PICB	0.00%
US high yield bonds	SPHY	0.00%
Non-US high yield bonds	IHY	0.00%
Emerging markets bonds	VWOB	0.00%
Global real estate	REET	2.50%
US mortgage-backed bonds	MBB	30.00%
US government bonds	VGSH	15.00%
Non-US government bonds	BWZ	15.00%
Gold	GLDM	15.00%