Accretive Q4 2022 Client Letter

Dear Clients and Friends of Accretive,

At the end of the fourth quarter, billable assets under management at Accretive totaled approximately $225 million.  As a result, we are waiving 7.5% of our management fee for the first quarter of 2023 under our Client Alignment Program™ (CAP).   As a reminder, our CAP program runs through March 31, 2023, and is subject to annual renewal.  We are pleased to announce that we are renewing the program through March 31, 2024.

Fourth Quarter Recap

The fourth quarter was a welcome change from the first three quarters of 2022, as markets recovered some lost ground.  

Equity markets rose as economic data suggested that inflation was decelerating.  In the US, stock indices large and small posted similar increases.  Outside the US, markets rose even more.  The standout were foreign developed markets, which posted percentage gains in the high teens.  It should be noted that much of the outperformance came from a depreciating US dollar, which had been very strong but reversed course in the quarter.  To the extent the dollar continues to weaken, that would be a tailwind for foreign stocks, but currency is a sword that tends to cut both ways and in an unpredictable fashion.  

We are in the midst of earnings season and with that comes initial guidance from many companies for 2023.  Many on Wall Street are forecasting corporate earnings to be soft, either from revenue decelerating or margins contracting.  We do not know if that is how the year plays out, but it may prove correct with respect to guidance, as companies today have no incentive to set expectations high.  To the extent that 2023 is a trough, and the bar for companies has been reset low enough, the market may confound investors as it starts to price some kind of recovery later this year or in 2024 and beyond.  

Bond markets recovered some of the losses experienced earlier in the year, as interest rates fell further out the yield curve and credit spreads narrowed a bit.  The Fed continued its tightening cycle but moderated the magnitude of the increases in December.  As we write this, moderation continued with another step down to 0.25%.  The Fed is signaling that there is another 0.25% hike coming in March.  Since that is within a relatively stable forecastable future, we take them at their word, but where things go from there is anyone’s guess.  Presently the market is forecasting interest rate cuts in the back-half of the year.  We note that forecast is at odds with the Fed’s own forecast, which is to hold the current interest rate regime for a considerable time.  It raises the question as to whether the market is fighting the Fed or the Fed is fighting the market.  We will not tackle that issue here, but if you would like our take, click here to read our January 2023 Market Update.

2022 in Review

In writing this, it is difficult to come up with something new to say that we have not said in prior letters or communications.  We won’t rehash our prior thoughts or commentary on the last year, but we will share some reflections.  In our previous letter we detail learnings and thoughts and not much has changed since then.  If you would like to read or re-read them, click here.  

Our initial reaction to 2022 is that it is a year we would like to forget but fortunately cannot and will not.  The equity market was difficult, with the S&P 500 declining more than 18%.  That’s a bad year, but bad years in the stock market are frequent enough that it is not all that surprising.  The real shock happened in the bond market, with the US Bloomberg Aggregate Index falling more than 13% on a total return basis.  That’s not only a surprising outlier outcome, but historic.  

Investors expect the stock market to decline from time to time, but they also expect their bond portfolios to offset declines as rates usually fall in tandem with markets.  The shock of 2022 is that stocks and bonds fell in tandem, as interest rates rose.  The result for most diversified portfolios was an outcome even worse than the 2008 financial crisis.  

What We Think

We think the consensus today is that economically speaking 2023 could be a challenging year, particularly in the first half.  That consensus may prove accurate, it may not.  It could be that the economy holds up in the first half of the year and it is the back half that gets difficult.  Unfortunately, even if any of these forecasts are accurate, they do not foretell the path of markets.  Markets are forward-looking, complex, and adaptive systems that have a way of making investors look foolish.  

It’s our view that, economically speaking, the COVID pandemic was a bit like an earthquake, and we have been living with the aftershocks the past 3 years.  Keeping with the earthquake analogy, it seems like the aftershocks are getting smaller with time, as the economy normalizes.  Whether or not a recession is the final aftershock, we do not know.  It is possible we have one, or the Fed induces one, but it is also possible the economy muddles through.  

The exuberance of 2021 has transitioned into a more sober environment.  As we come into 2023, uncertainty seems high, but expectations seem low.  The volatility of 2022 was uncomfortable, to say the least, but that is a feature of markets.  We observe that asset prices tend to fluctuate more than intrinsic value and long-term fundamentals.  To the extent reality is less bad than the expectations, the market may surprise investors in a positive way.  Conversely, to the extent it is worse than expectations, like the inflation forecasts from a year ago that consistently undershot realized inflation in the first three quarters of 2022, the market would surprise investors in a negative way.  

From our perspective, [in the context of a longer time horizon] valuations seem generally more reasonable.  For more conservative investors, fixed income seems relatively attractive for the first time in a while.  While cash can seem appealing at times, moving to cash introduces the question of when to move out, particularly if short-term rates head lower at some point.  

Sometimes the question of cash is a financial planning question, how much is needed to cover some period of expenses, but oftentimes the topic of raising cash is a market-timing question in disguise.  Generally, we are not believers in market timing approaches.  There’s the initial question of when to go to cash and, assuming the timing was correct, when to deploy the cash and what to deploy it back into.  We think making more decisions introduces more opportunities to make mistakes, potentially costly ones.  To the extent we hold cash or equivalents as part of the portfolio, it is because we exited a position without an immediate replacement position at the time.  Our view is that there is comfort in cash, but also opportunity cost and reinvestment risk.  

As it relates to doing what is comfortable, we have noticed that particularly after years like 2022, investors (and oftentimes their advisors) tend to seek out what’s done well recently and shun what’s done poorly so their portfolios align more closely with the prevailing narrative.  That’s understandable, as there is comfort in being aligned with the narrative.  Often, narratives can change, sometimes unpredictably, or prove incorrect.  Another way of thinking about investing on narratives is buying what’s popular.  All else being equal, we would rather look at what is unpopular for one reason or another and how that narrative could change for the better over a few years.  

What are we doing?

Late in the fourth quarter we did tax-loss harvesting across taxable accounts.  We did so with the goal of reducing capital gains to the extent they were realized throughout the year and generating tax-loss carryforwards to be used in future years.  In doing so, we attempted to remain in an invested position that was similar, but not identical, to the position sold.  

As we manage portfolios, we have a belief that less is more when it comes to trading activity.  That said, we consider many potential positions and scenarios but contemplate more potential changes than we make.  We anticipate having a relatively normal level of activity, but how much depends on how markets evolve, the opportunity set, and expectations relative to asset prices.  

Concluding Thoughts

2022 was, in many ways, the most challenging year we have experienced.  We found it even more challenging, but perhaps less frightening, than the 2008 financial crisis or the March 2020 pandemic.  2023 is off to a surprisingly solid start, but whether that continues, holds, or reverses remains to be seen.  

We appreciate the trust and confidence our clients have in us. If you have any questions or concerns, please feel free to contact us.  We would welcome speaking with you.

Sincerely,

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Gary C. Ribe, CFA, CFP®

Chief Investment Officer, Managing Partner

gary@accretivewealthpartners.com

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