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Quarterly Economic Commentary - January 2023

By Jim Watts, Senior Portfolio Manager

12/31/2021 12/30/2022 %Gain/Loss
33,147 -7.0%*
S&P 500
4,766 3,840 -18.3%*
NASDAQ 15,645 10,466 -32.9%*

*Total return including dividends

Q4 2022

I don't intend to spend much time on the results of 2022 but will briefly recap and then focus on 2023. As you can see above, the equity markets had a very tough year. What you don't see, and is an anomaly, is that the fixed-income markets were just as challenging as the equity markets. In a typical market, when equities are down, the fixed-income market is up, and vice versa. In 2022, the 10-year U.S. Treasury Bonds were down 16.2%, the U.S. Bond market was down 12.9%, Global Bonds were down 16.1%, and Municipal Bonds were down 8.5%. While the overall results of 2022 were not surprising, they were definitely disappointing. 

Most of the issues that we watched in 2022 continue into 2023. Geopolitical issues are still present and escalating. The war in Ukraine is dragging on and getting direr by the day. China's COVID issues seem to be unending. North Korea continues to "push the envelope" with South Korea. The crisis at the border has gotten worse and there is no end in sight to the stream of aliens trying to get into the U.S. Europe is still wrestling with the exploding cost of high energy prices. We are seeing energy prices resuming their climb after some much-needed relief. The political environment in the U.S. is still divisive. Inflation is still extremely high. The Fed is moving to combat that but at the risk of pushing the U.S. into a recession. That old saying, "the more things change, the more they stay the same," seems to apply here. 

Internationally, the war in Ukraine is intensifying with the type of weapons used and the damage being inflicted. For now, there is no end in sight, only more suffering and destruction. China has a strong desire to exit the COVID era. Despite those desires, they can't recover from one strain before another one or two mutates. Their economy is suffering and will impede global GDP growth until they can participate on a healthy basis. Europe, while having a mild winter thus far, is expected to have energy shortages over the next few months. They can't produce enough and one of their major issues now is that they don't have enough storage to hold reserves until they are needed. These are not all of the international issues, but the most pressing currently.

Here in the U.S., while we now have a more divided government, it is not as divided as predicted in late October. Still, 2023 brings many opportunities for legislation that can make some real impact on our economy and the way of life in the U.S. Immigration reform could help improve the border issues, the lack of workers to fill jobs, the strain on governmental budgets, and maybe get a better handle on imported crime.

If you are like me and still have to purchase gas or diesel, you are beginning to see prices move back up at the pump. We enjoyed some relief in the latter part of 2022, but now the easy fix is over. Strategic Petroleum Reserves have pretty much been depleted and now need to be built back up. As Europe begins to feel the full effects of winter, they will need more petroleum. If China can return to a more normal, healthy economy, its demand will go up. Demand will increase in 2023 and so will the cost of energy, for all of us. 

We believe that the Fed is pretty close to taking a pause, probably by the end of the first quarter. As such, web believe that most of the rate hikes are already in play, with just a few more, less extensive rate hikes to come. Some of you may have heard me make this statement, I believe that bringing down inflation is like losing weight, the first few pounds come off fairly easy. It's those last few, the ones needed to meet your target, that are the toughest to meet and maintain. As such, the improvement we have seen thus far is the easiest to accomplish. It will be when we get inflation down to the 4% level when it gets almost impossible to move it lower, especially if my earlier assessment of rising energy prices comes to pass. 

We are expecting the following to materialize in 2023 as we move through the year:
1. Volatility will continue, at least through the first half of the year.
2. The Fed will continue to raise rates through at least the first quarter.
3. The inflation number, CPI, will show at least one increase, instead of continuing the downward trend.
4. The Fed will pause, but not pivot in 2023.
5. Energy prices will rise, with oil reaching at least $100 per barrel and prices at the pump at roughly $4 per gallon, driven by increased demand from Europe and China.
6. The war in Ukraine will continue to wreak havoc on the international community and economy.
7. We expect that the bond market will turn around a see a strong 2023 performance.
8. North Korea will become more emboldened in their military endeavors. 
9. Iran will once again come to the forefront as a global threat.
10. The stock markets will end the year with a mid-to-high, single-digit return. 

If you have continued reading to this point, I applaud you. While the previous information is not very encouraging, to be honest, we believe these items are very likely to happen. We feel that the equity markets are poised for some positive news and are ready to build on that. It's likely that the continued reductions in year-over-year inflation will be a driver for the markets, and so will the Fed pause. While we expect inflation to be stubborn, especially given the Fed's target of 2%, we believe that the market is willing to accept as much as 3.50% inflation as reasonable. So, the markets should improve as we move forward in the year. 

To prepare for these expectations, we have been and will continue to do the following. On the fixed-income side, we will continue to take advantage of rising interest rates and extend our maturity to capture higher rates for longer. During 2022, we increased our cash allowance to provide protection from the storm. This will most likely be reversed early in the year as the negative sentiment in the equity markets presents us with an opportunity to position portfolios for the market moves that we anticipate later in 2023. 

We appreciate each client’s uniqueness and will always strive to do what is best for each individual client. Please do not hesitate to ask us questions or express your concerns.  This is your money and we are your stewards. 

Investments managed by KS Bank’s Trust Department are: Not Insured by FDIC or Any Other Government Agency | Not Bank Guaranteed | Not Bank Deposits or Obligations | May Lose Value
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