Below is an excerpt containing this quarter's market commentary. To download a copy of our full quarterly newsletter, click the Download Article link to the left.
By the Numbers
With 2023 now in the rear-view mirror, stocks and bonds delivered a marked improvement over 2022. The S&P 500 delivered an impressive result of 11.68% in the fourth quarter and an even more remarkable 26.26% over the course of the year. Similarly, the NASDAQ Composite posted gains of 13.84% for the quarter and a whopping 44.70% for the twelve-month period. For investors owning mid-cap equities, the S&P 400 index delivered returns of 11.66% for three months and 16.39% for the year. Small-cap investments, as measured by the S&P 600, recorded gains of 15.07% for the quarter and 15.94% for the full year. In global markets, the MSCI Emerging Markets index lagged most other risk assets with returns of 7.84% for three months and 10.12% for the year. Lastly, the MSCI EAFE index, representing developed international markets, returned 10.47% for the quarter and 18.95% over the twelve-month span. (See Figure 1) Broadly speaking it was an excellent quarter and an even better year for stocks of all types.
In a similar fashion, fixed income rallied strongly in the fourth quarter to overcome what had been shaping up to be another disappointing year. The Bloomberg U.S. Aggregate Index returned 6.8% for the quarter and 5.5% for the full year, saving the index from what could have been an unprecedented third consecutive year of declines.
High yield was the clear winner for 2023, with a 13.4% return. (See Figure 2) Both high yield and corporate bonds benefited from the falling interest rate environment as well as the now popular narrative that the Federal Reserve will achieve a soft landing (whereby inflation is tamed and the economy avoids recession).
Don’t Fight the Fed
What prompted this sudden shift in animal spirits in the markets? Once again, we can point to the Federal Reserve. While the last Fed rate hike was in July of this year, it had not become clear that they would be on pause for the next few months and perhaps beyond. But as U.S. economic data began to show signs of deceleration, particularly in the fall, both bond and stock markets sensed the Fed had perhaps raised rates far enough to tame inflation. The December Federal Open Market Committee meeting confirmed that as Jerome Powell reported they had likely raised rates far enough and their intended effect was evident in more recent inflation and jobs data.
Markets reacted immediately to this news and continued to rally. What had been a market where returns were concentrated in a short list of technology stocks began to broaden out. As an example, small cap stocks, which on a year-to-date basis were barely positive entering the month, rallied over 14% just in the month of December. Looking at the range of returns for equities for the quarter tells the same story.
With such a strong result in 2023, many are wondering what might be in store for 2024. As we reflect on the market trends heading into 2024, the S&P 500's year-end rally has been propelled by an expansion in valuations (multiples), driven by the forecast of strong earnings growth in the upcoming year and a rate cut currently expected as soon as March 2024.
According to Factset, the forward 12-month P/E ratio for the S&P 500 is 19.3. This P/E ratio is above the 5-year average (18.8) and above the 10-year average (17.6), underpinned by robust earnings estimates for 2024. Wall Street's consensus suggests a significant margin expansion with a projected 10.6% growth in earnings, marking a significant increase over 2023 tepid earnings. The trajectory of stock market returns in 2024 is likely to hinge on the realization of these earnings growth expectations. If these expectations don’t come to fruition, it’s likely we will see prices revert, given the run up we saw in 2023. Key tailwinds include decreasing input costs relative to consumer costs and potential rate cuts in a soft-landing scenario, while risks involve persistent wage growth and prolonged high-interest rates that put downward pressure on margins. To successfully navigate the 2024 market, a strategy focusing on quality stocks in stable sectors, offering strong profits, cash flows, and balance sheets, alongside growth at a reasonable cost should perform relatively well.
Inflation, measured by the year-over-year change in PCE, has fallen sharply from its highs of roughly 7% in June 2022, to 2.6%, while GDP growth has been stable. This has led the market to price in roughly six rate cuts in 2024, higher than the average Fed Governors latest December estimate at three cuts in 2024. The Fed expects inflation to moderate by year-end to 2.4%, close to their 2% target, with real GDP growth of 1.4%. Slowing inflation and growth should continue to put downward pressure on yields, which continue to make bonds look attractive for the year.
In 2023, the resilience of U.S. consumers was fueled by low unemployment, robust wage growth, and residual savings from COVID relief efforts. This economic scenario particularly favored those with excess savings and substantial assets, like homeowners, who benefited from high returns on cash and near-record property values. This shift in consumer wealth spurred growth in service-based sectors, aligning well with the U.S. economy's significant service orientation, which accounts for nearly two-thirds of its composition.
This dynamic contributed to stronger economic performance in the U.S. compared to regions more reliant on goods production.
However, looking ahead to 2024, some of these positive factors may reverse. The rapid depletion of COVID-era savings, surging credit card debt exceeding $1 trillion, and a decline in job openings could present new challenges. These emerging trends suggest potential headwinds that could reshape consumer behavior and impact economic growth in the coming year.
The political landscape in 2024, both domestically and internationally, brings a wave of uncertainty to the markets. In the U.S., the election year could introduce volatility as policies and leadership are debated. However, according to Goldman Sachs, it is worth noting that the market has returned 8% on average during election years since 1976. Globally, ongoing tensions such as the Ukraine-Russia War, conflicts in the Middle East, and the U.S.-China trade dispute, along with potential escalations between China and Taiwan, could affect global trade dynamics and investor confidence. These geopolitical factors are likely to influence market sentiment and could lead to shifts in investment strategies and economic forecasts.
In conclusion, our outlook for 2024 is cautious. Stocks are highly valued and could experience more volatility in the first half of the year. By mid-year investors should have better visibility on the Fed and the economy, which may provide a runway for markets to move higher. For now, we are positioned to minimize volatility and could use any market weakness to become more opportunistic. Our strategy still emphasizes diversification and a balanced approach to asset allocation. We are prepared to navigate the intricacies of the market, leveraging our expertise and insights to guide our clients through the year's opportunities and challenges. Our commitment is to provide strategic, informed guidance, helping you achieve your financial goals in a dynamic and evolving economic environment. We value the trust you have placed in our team to steer you through 2024 and beyond with confidence and clarity. Happy New Year! ■