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Oarsman Outlook: January 2023

January 25, 2023

All major categories of financial assets produced solidly positive investment returns in the October-December period.  Large-company U.S. equity results were unusually diverse: the S&P 500 and Dow Jones Industrial Average gained more than 7% and nearly 16%, respectively, while the tech-dominated NASDAQ Composite was down 1%.  Small-company stock returns were in the high single digits.  A decline in the foreign-exchange value of the U.S. dollar boosted non-U.S. results, with both developed- and emerging-market equities providing double-digit gains.  Real-estate results were mixed: non-U.S. and resource-related issues rose more than 10%, on average, while the traditional, domestic category produced low-single-digit gains.  Commodities were mostly higher: gold: +9%; oil +7%; copper: +11% (though natural gas was down nearly 40%).  Bond yields ended modestly higher (the 10-year Treasury finished at 3.88%, compared to 3.81% at the end of September), though the net change masked substantial volatility that saw rates as high as 4.33% and as low as 3.42%. Credit spreads narrowed, resulting in positive returns from most bond categories.

 Among large-capitalization U.S. stocks, companies in the Energy, Financial Services, Industrials and Basic Materials sectors generally provided the strongest results; names in the Consumer Discretionary, Communication Services and Technology sectors lagged.  The “value” investment factor dominated “growth” across all market-capitalizations, though the effect was most pronounced among large-company stocks.


The final three months provided a welcome respite from an otherwise dreadful 2022.  Despite late-year gains, both stock and bond markets recorded historic drubbings: the S&P 500 finished the year down 18% (its worst showing since 2008) while the broadest fixed-income benchmarks were off 13% – a figure that left bond-market mavens scrambling to find a parallel.  Cumulative portfolio losses worldwide were estimated to approach $30 trillion – more than a quarter of annual global economic output.

 As 2022 wound down, the war in Ukraine and global COVID pandemic continued to weigh on investors’ minds.  Ukrainian advances slowed as winter and newly conscripted Russian reinforcements solidified front lines while Russia resorted to missile and drone attacks on civilian infrastructure.  Mild fall weather allowed European gas storage to be filled near capacity, alleviating fears of rationing and allowing prices to subside from unimaginable to merely unprecedented.  And in one of the period’s biggest surprises, China abruptly abandoned its draconian COVID-containment polices in the face of growing public disaffection and cratering economic activity.  Amid unofficial reports of soaring rates of infection, hospitalization and death, the virus appeared to run rampant among China’s huge and relatively unprotected population.        

The U.S. economy continued to labor in the face of stubborn inflation and interest rates pushed dramatically higher by restrictive Federal Reserve monetary policy.  Following declines in each of the first two calendar quarters, aggregate economic activity (GDP) expanded at an above-trend +3.2% (annualized) rate in the third, though this figure was flattered by unsustainable strength in the export sector that masked flagging consumer spending and a faltering housing market.  More timely data, too, were mixed: monthly job creation averaged better than 270,000 – a deceleration compared to the post-pandemic boom but more than sufficient to keep unemployment at a super-low 3.7%.  Easing inflation – in particular, plummeting gasoline prices – boosted consumer confidence from mid-year doldrums.  Purchasing-manager surveys suggested a deepening manufacturing slowdown offset by a relatively steady service sector.  And the real estate market was clearly pressured by the largest calendar-year increase in mortgage rates on record: housing starts, building permits and sales prices all declined steadily from early- or mid-year peaks. 

 While inflation remained a focus among consumers and investors alike, much of the news was good for a change.  Besides the gas pump, other salutary anecdotes included rapidly declining shipping rates and used-car prices (though wage growth remained strong).  Having reached a rate of 9.1% in June, year-over-year price increases captured by the consumer price index (CPI) slowed in each of the next five months, reaching 7.1% in November. (The “core personal consumption expenditures” measure preferred by Federal Reserve policymakers eased to +4.7% from an early-year high of +5.4%.)  The twelve-month figures belie an even more encouraging recent pattern: the three-month rate of change (CPI; September-November) fell below 4% and the one-month change for November equated to an annual rate below 2%. 

Overseas economic activity was subdued.  Though Euro-zone GDP notched a +1.3% gain in the July-September period, regional purchasing-manager surveys were mired in contractionary territory for six straight months through December.  Most observers expect the region to have tipped into downturn in the fourth quarter, though a less-dire-than-feared energy supply/price environment combined with generous fiscal support held hope that any dip could be relatively shallow.  Following a strong April-June period, the Japanese economy contracted at a 0.8% rate in the third quarter, hampered by one of the world’s worst COVID resurgences; current-period data suggested a modest rebound.  In China, intermittent lockdowns continued to wreak economic havoc: amid various government measures aimed at shoring up the industrial and real-estate sectors, activity accelerated markedly in the third quarter only to tank again in the fourth.  The latest official statistics were released following October’s Communist Party Congress with no mention of a full-year growth target (previously +5.5%); impartial observers expect the figure to come in around +3% – far below 2021’s +8.1% and the weakest on record apart from 2020’s COVID-induced +2.2%.      

Central bankers pressed ahead with their ambitious if belated quest to tame inflation.  The Federal Reserve raised overnight rates an additional 125 basis points (1.25%) at its early-November and mid-December policy-setting meetings, bringing cumulative tightening since March to an astonishing 425 basis points (just how astonishing is captured by the fact that, a year ago, the central bankers themselves expected rates to rise by no more than 100 basis points in 2022).  And with a surprise December tightening, the Bank of Japan finally joined what had become the most concerted anti-inflation crusade in four decades.  Although the Fed’s December rate hike (of “just” 50 basis points) represented a downshift following four consecutive 75-basis point moves, the U.S. central bank nonetheless shocked market participants with “hawkish” post-meeting communications (the more surprising given recent benign inflation news): projections for end-2023 inflation, interest rates and unemployment all moved up, while the bankers’ GDP-growth guesstimate was trimmed to a meager +0.5%.

Other noteworthy late-year developments included a reversal of fortune for the U.S. dollar, whose foreign-exchange value declined some 8% from an October multiyear peak, plausibly reflecting investors’ view that the point of maximum Fed hawkishness relative to other global central banks had passed.  Meanwhile, the sudden and spectacular denouement of Sam Bankman-Fried’s crypto-currency/hedge-fund empire – FTX/Alameda Research – came as a shock to few; from the late-2021 highwater mark, the collective crypto universe had by yearend declined in value by some 70%, representing a cumulative loss estimated at $2 trillion.  And although a widely anticipated “Red Wave” failed to materialize, the U.S. mid-term elections yielded the generally unsurprising result of split control of Congress (though the inability to name a House Speaker raised some eyebrows), promising a heightened level of legislative dysfunction in the year ahead.

The most prominent pattern within the U.S. stock market was dramatic underperformance by mega-cap stocks in the communications/technology/media super-sector.  The stock prices of the five largest companies (Apple, Microsoft, Google-parent Alphabet, Amazon and Tesla) declined by an average of -18% during the October-December period, compared with an average gain of more than 11% for the other 495 stocks in the S&P 500. (The corresponding twelve-month figures – minus-42% for the five mega-caps versus minus-13% for the rest – closely mirrored the late-year divergence.)  Soberingly, the twelve-month decline in just these five stocks represented a loss of over $4 trillion, dwarfing the blow absorbed by (now) widely mocked “crypto bros.”

Earnings reported by large publicly-traded U.S. companies during the period – mostly covering the July-September quarter – came in a healthy +14% higher than the year-ago figure.  Wall Street analysts collectively expect growth to slow to +7% in the fourth quarter and just +3% in 2023.  Estimates for 2023 were steadily trimmed through most of 2022, a process we suspect has further to go in the face of weakening economic momentum.

What’s Changed?

To provide insight regarding recent stock market performance, we can deconstruct the three-month return from stocks into three components:

1)   Dividend Income (for three months this is the annual yield divided by four)

2)   +/- Change in Earnings per Share* (average for S&P 500 companies)

3)   +/- Change in Valuation (Price/Earnings Ratio)

      = Total Return

        * based on forecast earnings for next 12 months (Source: S&P Outlook)

So, what changed during the recent quarter to produce the +7.6% S&P 500 total return?

Fourth Quarter (October - December) 2022

Dividend Income



+ Change in Earnings


+ Change in Valuation


= Total Return


Our read: Declining forward earnings (as seen over the past three months) are likely to be a persistent headwind in the New Year.


Barring unforeseen geo-political and/or political events (e.g., a major deterioration in US/China relations; a Capitol Hill debt-ceiling debacle), the key market drivers in coming months will likely be evolving investor views regarding the “end game” of the Fed’s historically aggressive tightening campaign and how that campaign eventually impacts economic activity and corporate profits.  A rapidly evolving Chinese COVID situation is a potentially important wildcard.

 The second half of 2022 saw a tug of war between investors (naively?) hopeful that inflation could be tamed without a recession and a Fed (repeatedly) seeking to temper those hopes out of fear that improving financial-market conditions might “undo” its efforts to cool the economy.  Most recently, investors first welcomed a growing stream of benign inflation data but then began to have second thoughts, particularly following the uber-hawkish December Fed meeting: an October-November rally in which the S&P 500 gained some 15% while longer-term Treasury yields fell from above 4.3% to below 3.5% was followed by a five-week stretch that saw stock prices slide anew and bond yields drift higher.  A related phenomenon has seen market-derived clues to future interest-rate levels diverge markedly from the Fed’s explicit projections: bond investors believe rates are near their peak and will be lower by the end of 2023 while Fed bankers are on record projecting multiple additional hikes and zero chance of cuts until 2024.  As 2023 unfolds, one or both of two developments seem plausible: Fed rhetoric (and, presumably, subsequent actions) becomes more dovish or investor expectations become more hawkish (and, consequently, bearish).  Incoming readings on inflation and growth will determine which side gains the upper hand.

Inflation is all but certain to continue edging lower in coming months.  Reflecting widespread deflation in the goods and energy sectors, the price-related components of each regional Fed manufacturing survey have reversed sharply from their peak levels. These data have a tight historical correlation to the CPI and imply a headline reading under 4% is not far off.  Both house prices and rents have also rolled over.  These enter reported inflation with a lag, meaning that upward pressure will first abate and then reverse as 2023 progresses.  The easing of many price pressures has not been mirrored in the labor market, where wage increases have remained near peak levels.  Wage growth, which many believe drives price changes in the important services sector, has become the Fed’s keenest focus.  Though some economists point to declining “voluntary quit rates” in the monthly Job Openings and Labor-Market Turnover Survey (JOLTS) as a harbinger of emerging slack in a white-hot jobs market, we’re not so sure the Fed agrees.  

Meanwhile, though recent “hard” data have reflected an economy valiantly holding out against recession, a marked deterioration in survey responses (collected by the regional Fed branches and commercial outfits like S&P Global and the Institute for Supply Management) augurs weakness ahead.  Other indicators of an impending downturn include a steeply inverted Treasury yield curve (long-term rates falling meaningfully below short-term) and a substantial – and accelerating – decline in the Leading Economic Index (compiled by the Conference Board).  Reflecting these dour trends, polls indicate substantial majorities of both Wall Street and Main Street economists expect a recession to begin within the next year (though for various reasons[1] many expect any downturn to be relatively mild).

Market participants seem convinced that the (perhaps too?) obvious easing-inflation/ flagging-growth backdrop, combined with the Fed’s recent extreme hawkish stance, favors the Fed “blinking” (i.e., raising rates less than projected; shifting to rate cuts before yearend).  But this outcome is far from assured: persistently strong wage gains, “sticky” service-sector inflation, and/or resilient growth data could readily lead the Fed on a less salutary path.

 Some observers have opined that the inflation/growth/rates debate is largely beside the point: regardless of whether the U.S. economy narrowly avoids recession, corporate profits are set to disappoint (at least to the degree investor expectations are accurately reflected in Wall Street forecasts, which is eminently debatable).  Many companies saw 2021/2022 sales boosted by pandemic-related stimulus windfalls and spending shifts that are now absent or reversing.  The same phenomena also inflated profit margins, which will increasingly come under pressure from higher wages, interest expense and capital expenditures.  Even absent an economic downturn, these factors would suppress earnings; recession would only compound the damage (a typical recession cuts profits by 15-25%, though a mild downturn could be less damaging).  While the current “bottom up” (company by company) estimate for 2023 earnings reflects just 3% year-over-year growth, recall that the base (2022; not yet “in the books” but getting close) will likely be an all-time high more than 40% above the 2019 figure (which was, at the time, also a record) – this seems a tall order given either a weak-growth or recessionary economic backdrop.

 We will be paying careful attention to developments in China, whose rapid emergence from nearly three years of isolation is sure to be… eventful.  Official lockdowns are likely (at least temporarily) to be replaced by extreme self-imposed caution among the hundreds of millions who have been told repeatedly how fearsome the virus is.  The sudden availability of a billion new “vectors” also raises the possibility of pernicious new virus variants that could spread around the world.  Beyond this initial phase – in perhaps six months’ time? – the biggest change will likely manifest in consumer behavior, which has been most stunted by pandemic restrictions. While this would bode well for consumption-oriented services businesses, it might have relatively little impact on China’s enormous industrial and real-estate sectors, which have much greater influence on the global economy.  In any case, Beijing will likely continue to unveil additional stimulus measures with the goal of returning the economy to a stronger growth path as soon as possible. 

 We remain cautious yet hopeful about prospective investment opportunities in the year ahead.  Yearend market levels that seem to reflect investor expectations of a relatively benign inflation/growth/interest-rates outcome presumably leave room for disappointment: stubborn inflation, a weakening economy and shrinking earnings could readily spark additional market swoons.  Our relatively conservative portfolio positioning reflects these near-term risks.  On the plus side, renewed market gyrations, though uncomfortable, could provide opportunities to acquire growth-oriented investments at increasingly attractive prices – a valuable buying opportunity for long-term investors.  In the meantime, we can think of worse things than patiently reaping the highest money- and bond-market yields in 15 years. 

As always, please let any of the Oarsman Capital team know how we can be of greatest help to you and your family.  We wish you a healthy and happy New Year.

[1] Reasons a downturn might be mild include: a well-capitalized banking system; strong consumer balance sheets; labor market shifts supporting healthy wage gains and a propensity for employers to “hoard” labor; the need for businesses to invest in enhanced supply chains and renewable energy sources; a potentially strong growth rebound in China.