In Review:
Following a tumultuous and disappointing 2022, we faced a fork in the road in terms of what would lie ahead in 2023: a recovery and rally to claw back some or all the previous year’s losses or a continuation of the pain and tough times. It was a deciding moment and may we all be thankful for the road not taken. The market GPS guided in the right direction, and 2023 ended up being a surprisingly strong year for both stock and bond markets.
Despite widespread predictions for a follow-through of the 2022 bear market and an all-but-assured recession, equity performance was impressive. The NASDAQ 100 turned in its best year since 1999 (+55%) while the most widely quoted market index, the S&P500, had an admirable +26.3% year. The Dow Jones underperformed slightly, while small caps enjoyed a furious rally over the final nine weeks of 2023 to conclude the year with a +24.3% mark. All told, equity markets finished 2023 on a high note and on the brink of brand-new all-time highs. It was a good year, and we will take it.
While stocks did most of the heavy lifting, bonds also delivered impressive returns throughout the year. Much attention was paid to the benchmark 10-year Treasury yield, which round-tripped the year to end unchanged after falling as low as 3.3% before ripping up to 5%. All told, the total return on the 10-year note was close to 4% and the aggregate bond index delivered 5.65% of total return in 2023. These returns were achieved despite the Federal Reserve raising interest rates four times throughout the year, capping a 2022 campaign which saw a cumulative 5.25% of aggregate rate increases.
The economy proved exceptionally resilient in 2023. A banking crisis in March resulted in the second largest bank failure in US history, with regional banks selling off nearly 30% in just three trading days. Although steadily decreasing, inflation remained high and the Fed seemed intent on hiking the economy into a recession. Nevertheless, a slew of fiscal and liquidity support was introduced to combat the drag from balance sheet unwinding, an inverted yield curve, and inflation. The labor market was robust throughout the year, as the unemployment rate is holding near generational lows as it appears increasingly likely that the Fed will achieve its highly coveted soft landing. From an economic standpoint, 2023 will be remembered for the recession that never materialized.
In Prediction:
Looking forward, the stage appears set for a continuation of the positive trends that played out in 2023. The economy, far from slowing down or contracting as many economists were convinced would happen, remains robust especially in the areas of job growth, consumer spending, and GDP. The so-called Goldilocks economy – not too soft, not too cold – is likely to set in and act as a foundation for full employment, economic stability, and continuously declining inflation. Against this backdrop, the economy can offer just enough support for financial markets to do well, without the threat of overheating and further potential rate hikes.
Inflation and interest rates will remain important going into the new year, but all signs point to a leveling out (finally). We have seen inflation cool steadily over recent months, largely a result of declining prices for food, energy, and commodities. However, services inflation and shelter (e.g., rent and housing costs) remain high and often operate on a lag, which could support price levels into 2024. In this case, it would be unlikely that the Fed would enact four interest rate cuts during the year as the markets currently predict. While one or two cuts may be in the offing, interest rates are likely to remain elevated as the Fed continues to try and pull inflation down to its 2% target rate.
From political and geopolitical standpoints, we are entering an election year which as always will include its share of fireworks and theatrics. But it is unlikely that the runup to the November vote will influence the financial markets to a large degree. Neither party wants a government shutdown, and even some of the most obstructionist politicians have shown signs of bipartisanship in recent months. More important than the election are policy risks, which include the deficit, debt, taxation and government spending. Any unforeseen developments in these key arenas could reset growth and economic expectations for the new year. Similarly, from a geopolitical view, the takeaway is that we need to be aware of the inherent risks (Ukraine war, Israel-Hamas war, China financial crisis), but markets do a very good job of pricing in such risk and can even rise in the face of them.
As we begin anew, we note that the S&P500 closed out 2023 with nine straight weekly gains, the longest streak since 1985. Ironically, 2023 was also the first year since 2012 that the bellwether index did not register a new all-time high during the period. With the Fed hiking cycle likely behind us, the broad indices are within striking distances of all-time highs. Upside momentum has been broadening in recent weeks, with increased participation, which could be yet another good sign for sustained market performance.
Thank you for your confidence and continued support. Happy New Year, and all the best for 2024.