Welcome to my latest video presentation for Mind Over Markets. The article below is a condensed transcript; the video contains further details and several charts.

Happy New Year! Let’s hope 2023 is kinder to our portfolios than 2022. The year that just ended was the worst for equity markets since the great financial meltdown of 2008. Investors accustomed to bull markets got a rude awakening.

The COVID pandemic and Russia-Ukraine war wreaked havoc with the global economy, sparking inflation and prompting central bankers around the world to tighten. When liquidity is removed from the markets, stocks tend to drop.

For calendar year (CY) 2022, the Dow Jones Industrial Average performed the best among the major U.S. indices, down 9.4%. The S&P 500, NASDAQ, and Russell 2000 declined 19.4%, 33.3%, and 21.3%, respectively.

Energy was by far the best performing sector in 2022, with a gain of 59%, representing the sector’s best year ever. Aside from energy, which benefited from soaring oil and gas price due to the Russia-Ukraine war and pandemic-caused supply imbalances, the three top-performing S&P 500 sectors for the year were utilities (-1.4%), consumer staples (-3.1%), and health care (-3.5%).

Sectors typically considered “defensive” were relative outperformers in 2022. (For a detailed breakdown of how all 11 S&P 500 sectors performed in 2022, see my video.)

Throughout this bear market, I’ve consistently recommended that you increase your exposure to recession-resistant sectors. These sectors also serve as proven inflation hedges, because they represent essential services and products that consumers need, regardless of economic ups and downs, even if prices are rising.

In 2022, value outperformed growth, which also stands to reason considering the difficult economic backdrop.

That said, in the back half of the year, the economy could perk up as inflation continues to fall and the Federal Reserve perhaps eases up on tightening. In this context, more cyclical sectors such as industrials and consumer discretionary should outperform. Be sure to stay properly diversified in 2023, with a balance between defensive and cyclical plays.

The same strategy applies to small cap stocks. Large-cap names outperformed the small fry in 2022, but as economic headwinds dissipate in the latter part of 2023, small caps could pick up steam.

The earnings picture…

Despite a problematic comparison to the unusually robust earnings growth rate in CY 2021, the consensus of analysts still expects the S&P 500 to post positive earnings growth in CY 2022.

As of January 2, 2023, the estimated year-over-year earnings growth rate for CY 2022 is 5.1%. That’s below the estimates of 9.1% on June 30 and 6.9% on September 30, but it’s still not an earnings recession.

Most of the year-over-year earnings growth for CY 2022 happened in the first half. An earnings decline of -2.8% is projected for the fourth quarter of 2022, as higher interest rates take their toll on businesses.

Higher input costs due to inflation also are biting into corporate profits. That’s why companies with pricing power are especially appealing now as investments, despite the overall cooling of inflation.

Eight of the 11 S&P 500 sectors are predicted to report year-over-year growth in earnings in CY 2022, led by the energy, industrials, and real estate sectors. Energy’s outsized prosperity has been the result of rising crude oil prices, although in the latter part of 2022, crude declined due to China’s COVID woes and overall fears of global recession.

History shows that investor patience is rewarded. We’ve just come out of a brutal 2022, but rarely have stocks posted back-to-back years of decline. Stay invested and stay diversified. All bear markets eventually end, and they’re invariably followed by bull markets that are longer and stronger than the bear that preceded them.

Questions or comments? Drop me a line: mailbag@investingdaily.com

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John Persinos is the editorial director of Investing Daily.

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