Stocks and bonds finally snapped their losing streak in the fourth quarter, ending 2022 on a positive note during an otherwise difficult year. Lower-than-expected inflation data signaled that inflationary pressures were easing and investors grew more optimistic that the Federal Reserve (the Fed) may slow its aggressive monetary policy tightening, reducing the likelihood of a deep economic contraction. Despite the fourth quarter gains, investors endured a historically volatile year amid uncertainties including multi-decade high inflation, rising interest rates, and the war in Ukraine. The S&P 500® Index lost -18.11% for 2022, marking the worst year for stocks since 2008. The Bloomberg U.S. Aggregate Bond Index, a broad gauge of U.S. bond market performance, dropped -13.01%, registering the worst year on record amid tighter Fed policy and sharply higher interest rates. 

Economic data was mixed in the fourth quarter amid tighter financial conditions. The ISM PMI Index readings on the manufacturing and non-manufacturing sectors both dipped slightly below 50 in December (readings below 50 indicate economic contraction).¹ U.S. GDP growth rebounded into positive growth, however, registering a 3.2% annual growth rate in the third quarter after two prior negative readings.² The outlook for the housing market remained downbeat with slumping new and existing homes sales as the 30-year average mortgage rate was 6.4% at the end of the year, not far off its high above 7%.³ The labor market has been resilient, although there are signs of cooling and there were several high-profile layoff announcements from large technology and finance companies during the quarter. The economy averaged 247,000 monthly new jobs created during the fourth quarter and the unemployment rate dipped back down to 3.5%. This matched the lowest level in half a century.

Even as inflation has started to roll over, the Fed has maintained its hawkish stance as it seeks to avoid missteps of the 1970s when policy was eased too soon and allowed inflation to become entrenched. In addition to its balance sheet reduction, the Fed hiked interest rates to the highest level in 15 years, raising the benchmark federal funds rate to a 4.25%-4.50%. However, the Fed did only raise rates by a half-point in December, breaking a streak of four three-quarter-point hikes earlier in 2022. The most recent projections from the Fed show expectations for the terminal rate climbing above 5% in 2023, while some investors are still holding on to hope for a rate cut later in the year. Central banks around the world have followed suit, with tighter policy rates from the Bank of England and European Central Bank. The Bank of Japan also surprised markets with a policy shift by allowing 10-year Japanese government bonds to fluctuate up to 50 basis points around their 0% target.

The S&P 500 returned 7.56% in the fourth quarter. Most sectors were positive led by gains of 22.81% in energy, 19.23% in industrials, and 15.05% in materials. Consumer discretionary and communications services were the only negative sectors with returns of -10.18% and -1.41%, respectively. For the full year, energy was a standout performer, gaining 65.72% in 2022, while all other sectors except utilities (+1.54%) were negative. Growth stocks significantly underperformed during the quarter as well as the full year, where the Russell 1000® Growth Index lagged the Russell 1000® Value Index by more than 20% in 2022. Meanwhile, large caps slightly edged out small caps to end the year. The U.S. dollar weakened significantly during the period, providing a major tailwind for international equity returns. The MSCI EAFE Index outperformed with a 17.34% gain, owing roughly half of its return to the weaker dollar. All countries in the Index were positive with double-digit gains in most markets led by Denmark, Austria, and Italy. Emerging Markets also delivered a robust 9.70% return for the quarter, led by Turkey, Poland, and Hungary. Chinese equities in the Index rose 13.60%, driven in part by a dramatic policy shift relaxing COVID restrictions during the quarter. 

The Bloomberg U.S. Aggregate Bond Index gained 1.87% in the fourth quarter. The 10-year Treasury yield climbed to a post-pandemic high of 4.25% in October before falling through early December and ending the year at 3.88%. Credit spreads tightened during the fourth quarter and investment grade corporates outperformed Treasuries with the Bloomberg U.S. Corporate Bond Index returning 3.63%. Non-investment grade “junk” bonds gained 4.17% for the Bloomberg U.S. Corporate High Yield Index. The Bloomberg U.S. MBS Index rose 2.14% while municipal bonds rebounded strongly with a 4.10% gain for the Bloomberg Municipal Bond Index. Lastly, foreign bonds benefited from falling rates and a weaker dollar as the Bloomberg Global Aggregate ex USD Index rose 6.81%.

Each of us at AMG Funds appreciates the continued opportunity to assist you with your investing needs.

¹ Source: FactSet, Institute for Supply Management

² U.S. Bureau of Economic Analysis

³ Source: FactSet, Freddie Mac

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Please note that all performance data and comments are for the period from July 1, 2022 through September 30, 2022. Any sectors, industries, or securities discussed should not be perceived as investment recommendations. The views expressed represent the opinions of AMG Funds and are not intended as a forecast or guarantee of future results.

The information and opinions contained herein are current as of September 30, 2022 and are subject to change without notice. Information has been obtained from sources believed to be reliable, but its accuracy, completeness, and interpretation are not guaranteed.

The Russell 1000® Index measures the performance of approximately 1,000 of the largest securities based on a combination of their market cap and current index membership. The Russell 1000® represents approximately 92% of the U.S. market.

The Russell 1000® Value Index is a large-cap value index measuring the performance of the largest 1,000 U.S. incorporated companies with lower price-to-book ratios and lower forecasted growth values.

The Russell 1000® Growth Index is a market capitalization weighted index that measures the performance of those Russell 1000® companies with higher price-to-book ratios and higher forecasted growth values.

The Russell 2000® Index is composed of the 2000 smallest stocks in the Russell 3000® Index and is widely regarded in the industry as the premier measure of small-cap stock performance.

The Russell 2000® Value Index is an unmanaged, market-value weighted, value-oriented index comprised of small stocks that have relatively low price-to-book ratios and lower forecasted growth values.

The Russell 2000® Growth Index measures the performance of the Russell 2000® companies with higher price-to-book ratios and higher forecasted growth values.

The Russell Midcap® Index measures the performance of the 800 smallest companies in the Russell 1000® Index, which represent approximately 25% of the total market capitalization of the Russell 1000® Index.

The S&P 500 Index is a capitalization-weighted index of 500 stocks. The S&P 500 Index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

U.S. Long Government Bond Index tracks the market for U.S. dollar denominated, fixed-rate, nominal U.S. Treasuries and U.S. agency debentures.

The MSCI World ex USA Index captures large and mid cap representation across 22 of 23 Developed Markets (DM) countries excluding the United States.

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The MSCI China Index captures large and mid cap representation across China A shares, H shares, B shares, Red chips, P chips and foreign listings (e.g. ADRs).

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The Bloomberg U.S. Corporate High Yield Bond Index is a total return performance benchmark for USD-denominated, high yield, fixed-rate corporate bonds having a maximum quality rating of Ba1/BB+/BB+ or below, as determined by the middle of the Moody’s, Fitch, and S&P ratings.

The Bloomberg U.S. Municipal Index covers the USD-denominated long-term tax exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and prerefunded bonds.

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