The employment situation continued to improve with the economy gaining 4.5 million jobs and finally surpassing the pre-pandemic employment level of 152 million jobs (Exhibit 1). Employment increased by 3.0% versus 0.5% growth in population. Unemployment rate declined to 3.5% matching early 2020 lows which were last seen back in 1950’s. Likewise, U-6 rate declined to 6.5%, which is an all-time low. This one is a broader measure defined as “Total unemployed, plus all marginally attached workers plus total employed part time for economic reasons”. So the labor market remains very tight despite Fed’s efforts to “break” it by raising interest rates.
Exhibit 1 – Employment
U.S. real GDP managed to grow at 2.1% for the full year despite being negative in Q1 and Q2 (Exhibit 2). A recession (decline in GDP) is widely expected to occur in 2023 or 2024, but we’ll see what actually happens. Inflation, of course, was THE economic story of the year. It technically clocked in at a pretty high 6.5% for the year, which was actually lower than 2021’s 7.0%. Excluding 21/22, last time the inflation was this high was 1981. Moreover, 6.5% year-end number doesn’t really capture inflationary pain experienced by the economy – monthly numbers averaged 8% and peaked at 9% in June. Wage growth was a healthy 4.6%, but it didn’t quite keep up with the robust inflation. U.S. Dollar had another strong year rising 7.2% (and was up almost 16% at its high in the fall). The dollar is important as it impacts all sorts of metrics from inflation and import/export dynamics to company earnings and performance of foreign investments in your portfolio (it also makes that trip to Europe feel so much cheaper).
Exhibit 2 – Growth & Inflation
Federal finances improved slightly form the insane pandemic levels, but still remain a mess (Exhibit 3). Public debt went up another $1.8 trillion but grew slower than nominal GDP. Growing your way out of debt is working for couple of years now. Federal budget deficit declined by 49% in 2022 but still amounted to $1.4 trillion or 5.6% of GDP. We’ve sent about $50 billion to Ukraine or only about 3% of the one-year deficit. It should improve further this year as divided government won’t be able to pass any massive fiscal stimulus measures (assuming we don’t have another major crisis!). Federal Reserve started to reduce its balance sheet this year as I wrote about a few months ago. It’s a very slow process that amounted to only 1.5% reduction to $8.1 trillion (it was $3.7 trillion pre-pandemic). I’ll take any reduction in these metrics though, at least we are starting to think about moving in the right direction.
Exhibit 3 – Debt & Deficit
So what about the stock market fundamentals? S&P 500 earnings decreased by a modest 4.2% (Exhibit 4). P/E ratio declined by 16% though, leading to the price drop of 19.4% (it’s a combination of earning and P/E change). On a positive note, S&P 500 dividends increase by 11% with yields rising to 1.7% from a paltry 1.3%. In the competition for income investors, however, bonds crushed these changes in stock dividends. The 10-year Treasury yield skyrocketed from 1.5% to 3.9% or 155% increase. 10-year rate actually hit a high of 4.25% in October, which was the highest since July 2008. The yield curve inverted across the board with shorter-term treasuries paying more than the long ones (e.g. current 3 month rate is 4.72%). These interest rate increases were accompanied by painful declines in bond prices discussed last week. Another unpleasant byproduct was a sharp increase in mortgage rates with 30-year doubling to 6.4% (it hit a high of 7.1% in November).
Exhibit 4 – Earnings & Rates
Driven in large part by high mortgage rates (see above) and affordability issues, the housing sector hit a wall last year (Exhibit 5). Activity and prices were robust through first half of the year and then things took a hard turn around June. My wife is a realtor and I saw it very clearly in her business – the mood started shifting from urgent “get me in now” to “let’s wait and see what happens”. Both new and existing home sales dropped by 16-18% and housing starts declined by 3%. Inventory of homes on the market gradually improved although it remains low at 3 months’ supply (6 months is considered a balance market). Depending on the metric you choose, home prices went up by 2% to 7%. All three have peaked in the summer and have pulled back moderately since. Our local Tucson market had a mixed year as well, you can check out this Long Realty report for more details.
U.S. auto sales dropped 7.6% to 14.2 million a year. High prices, low inventory and supply chain issues contributed to this dynamic. Here is an interesting analysis of new car prices (just wow).
Exhibit 5 – Housing & Autos