Cheap money—an incredibly popular and influential feature of finance that led to a surge of wealth, speculative trading and booms in ridiculous investments such as meme stocks and digital images of cartoon monkeys—died suddenly in 2022. It was 14 years old. Cheap money is survived by its estranged relative, expensive money.
The death has been attributed to a surge in consumer inflation that forced central banks around the world to aggressively lift interest rates to the highest levels in a decade and a half. The end of cheap money has been mourned throughout the financial world, most loudly in the US stock market, which saw its worst decline since 2008 amid the disappearance of what had come to be known as the "Fed put": the belief that the Federal Reserve would always come to the rescue with a more market-friendly policy if stocks tumbled.
Cheap money's demise caused similar grief in the bond market, where total returns were the most negative on record. Even the Treasury's inflation-protected securities, the bonds known as TIPS that are meant to shield retail investors from the damage that inflation does to savings, lost almost 12% in 2022. The despair reached deep into the cryptocurrency market, which lost 70% of its value in 2022. The schadenfreude derived from that anguish was arguably the only bright side for many of the adults in traditional finance.
Now that the calendar has flipped to 2023, it's clear the grief will continue while financial professionals and amateurs alike confront a new investing regime, the likes of which few have experienced. Even now that most of the world's central banks are nearly done raising interest rates, the newfound influence of expensive money has only just begun to shake the foundations of the financial world.
For market participants whose careers hold more tomorrows than yesterdays, 2023 will be the first full year of navigating a climate that's not dominated by the halcyon glow of cheap money and plentiful liquidity.
The US housing market has already begun to deteriorate after mortgage rates doubled last year, with new home sales declining from a peak of more than 1 million a month in August 2020 to 640,000 in November and monthly existing home sales decreasing by a third. The pain may just be starting for housing, with home prices expected to post a full-year drop in 2023 for the first time in more than a decade.
In tandem with the death of cheap money came the demise of TINA: the teaching that "there is no alternative" to stocks when interest rates are at rock bottom. The pullback from equities and the resulting price gyrations are widely expected to continue, at least in the first half of 2023. The average estimate from Wall Street strategists tracked by Bloomberg calls for the S&P 500 to end 2023 at 4,078—about 6% higher for the year. That gain would only return the index to where it was at the beginning of December 2022.
Along with the new risks that higher interest rates bring in 2023, there will be opportunities. Bonds, the long-overlooked alternative to equities, are now offering the types of yields that have Wall Street pundits advising investors to add a larger helping of fixed-income assets to their nest eggs than they have in years. As strategists at UBS AG wrote in a look-ahead note, it's time to rethink traditional strategies such as holding 60% of investments in stocks and 40% in bonds. "The recommended equity-bond portfolio is much closer to 35-65 than 60-40," UBS advises.
The juicy yields that now offer an alternative to stocks came as a result of carnage in the bond market in 2022 that was unheard of in modern history. The Bloomberg US Treasury Index has experienced only six down years since it was started in 1974. Two of those were 2021 and 2022, the index's only back-to-back annual losses, with last year's 12% decline more than triple the size of the previous worst year's, which was 2009's total return of -3.57%. The Bloomberg US Aggregate Index, which also includes investment-grade corporate bonds as well as mortgage- and asset-backed securities, has had only five down years in its history since 1977. In 2022, the index plunged 13%.
Investment-grade corporate bonds, now sporting yields of almost 6%, are looking especially enticing given that they, as Goldman Sachs strategists put it, "are relatively insulated from an economic downturn." Bank of America is expecting total returns of about 9% for US blue-chip corporate bonds this year.
Last year's market turbulence meant private equity also ran into trouble financing deals. As a result, an obscure corner of finance known as private credit has blossomed. While not exactly the type of offering most of us can find in our 401(k) plans, pension funds and investment firms with lots of money to put to work have flocked to private debt, which could have worrisome consequences.
As the lagging effects of the Fed's interest-rate hikes kick in with full force in the first half of the year, the consensus seems to be that the economy will weaken and inflation will come back down to Earth, if not completely back to the Fed's 2% comfort zone. That won't necessarily mean a rebirth of cheap money and everything that comes with it, but it should mean that money won't continue to get more expensive. So while the notion of "there is no alternative" to equities isn't likely poised for a revival this year, at some point in 2023, beaten-down stocks will probably emerge as an attractive alternative. A buy-and-hold investor with a long-term horizon could be forgiven, maybe praised, for just buying and holding through it all.
Cheap money may have passed away in 2022, but reports of the death of equities are likely, to borrow a line from Mark Twain, greatly exaggerated.
Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.