Source: PaxForex Premium Analytics Portal, Fundamental Insight
With the S&P 500 averaging a 14.3 percent annual return over the 10-year period from early 2012 through 2021, investors were in for a nasty surprise when the broad U.S. 500 index ended 2022 down 19.4 percent. To say that pessimism is very high now would probably be an accurate assessment, as things continue to get worse because of expectations of a recession.
So, what's in store for the S&P 500 this year? Will it be able to recover? That's what the smartest investors are wondering today.
While it is impossible to predict how the market will behave in any given year, no matter how hard Wall Street strategists try, we can look to history to get some context. To begin with, two years in a row of negative returns for the S&P 500 is extremely rare.
The last time it happened was during the dot-com crash about 20 years ago. It has happened four times since the Great Depression began in 1929. Who knows? Maybe we are now looking at two consecutive years of declines.
The last time the S&P 500 experienced a decline was in 2008 when the index lost 38% of its value. The following year, it soared by 23%. Obviously, this bodes well for the outlook for 2023.
However, investors should keep in mind the current macroeconomic backdrop. Inflation has been high since mid-2021, forcing the Federal Reserve to aggressively raise interest rates to suppress demand.
Although the December consumer price index rose 6.5% year-over-year, continuing several months of declining growth, there is no doubt that inflation is still a big problem for the economy. Consequently, the central bank will continue to raise interest rates in 2023. Normally, this is not a favorable environment for an equity market correction.
Nevertheless, the mindset of the individual investor should not change. The focus should still be on owning a diversified basket of high-quality companies that you plan to hold for the long term. The only caveat to this investing strategy now is that you may want to exclude companies that are not generating positive net income or have significant debt.
That's because many growth technology stocks, for example, that fit this category perfectly, have had an absolute meltdown in the past year. And this was largely due to their deteriorating financial situation. With rising borrowing costs and heightened macroeconomic uncertainty, it's better to own companies with low or zero debt and positive free cash flow (FCF).
This fresh perspective is because we simply do not know what will happen next in the world or in the economy. Just look at the last three years.
We had a global pandemic that brought the economic engine to a halt. Then we had massive stimulus measures, supply chain disruptions, skyrocketing inflation, and now a tightening of monetary policy. Hardly anyone could have foreseen this sequence of events.
Accepting how unpredictable things really direct attention to looking at financially sound companies as opposed to the more speculative names that may show better growth.
The S&P 500 may or may not recover in 2023. However, this should not be a big problem for long-term investors. What you can control should not change, which is to remain optimistic and look at the long term. Your portfolio will benefit tremendously, and you can keep your peace of mind.