It's (Almost) A Wrap!- 2023 A Look Back

After a very difficult year for markets in 2022, this year has seen a welcome snap back in the stock market, and even bonds are getting in on the positive returns. As the Fed seems to be signaling an end to interest rate hikes, the outlook for 2024 is one of cautious optimism. Assuming inflation continues to come down and the labor market remains strong, the Fed may be able to pull off a soft landing. If that is the case, both the stock and bond markets should benefit in the year ahead. If the economy rolls over and we get a spike in unemployment, the stock market will likely experience a pullback. Either way, bonds should benefit from lower interest rates due to lower inflation and/or a slowing economy.

Soft Landing vs. Hard Landing

Going into 2023, there were concerns that the economy would slow under the weight of 4.25% in interest rate hikes by the Fed in 2022. The Fed continued to raise rates by an additional 1% in 2023 before pausing in the September Fed meeting. The consumer continues to spend, as does the government. The resumption of student loan payments and the depletion of savings may lead to more conservative consumer spending ahead. This coming year is an election year, and the current administration will do its best to keep the economy going. If the economy does roll over, then opponents will look to use that as fodder for change.

Inflation

Headline consumer price index (CPI) inflation peaked at 9.1% YoY in June of 2022, but has come down to just 3.2% YoY as of October of this year. The core personal consumption expenditure index (PCE) is the Fed’s preferred inflation measure, and it came in at 3.5% YoY in October. The Fed’s long-term target for inflation is 2%, so although it has come down quite a bit, it still has a ways to go.

Fed Expectations

The Fed continues to infer that they will continue to keep interest rates higher, but the markets continue to shrug that off. Investors are now expecting the Fed to lower rates by more than 1% in 2024, which is a disconnect from the Fed’s current forecast for 0.5% in reductions in the second half of the year.

The Labor Market

The labor market has been resilient throughout the year, although there are some signs of slowing down. For much of the year, employees and job seekers held the upper hand in being able to negotiate higher salaries and benefits. Job openings have been declining throughout the year but are still higher than pre-pandemic levels. The number of workers voluntarily quitting is also slowing as workers see jobs as less plentiful and harder to get. If we continue to see the labor market soften, it will raise concerns about a potential recession in 2024.

Treasury Yields

The U.S. yield curve has been inverted since October of 2022. Historically, anytime we’ve experienced an inverted yield curve, it has led to a recession. The 10-year U.S. Treasury yield at one point topped 5% but has come down quite dramatically as economic and inflation data have shown continued signs of softening. That has led to positive bond performance as interest rates have come down. Year-to-date returns on bonds were negative in October as measured by the Aggregate Bond Index¹ but have rallied over the past month and a half to show positive returns of ~3%. Meanwhile, money market funds continue to yield ~5% for very little risk.

The “Magnificent Seven”

The S&P 500 is on track to finish strong, with a gain of ~21% through November. Much of this performance can be attributed to 7 mega-cap technology stocks – Apple (AAPL), Amazon (AMZN), Alphabet (GOOG, GOOGL), Nvidia (NVDA), Meta Platforms (META), Microsoft (MSFT), and Tesla (TESLA). These stocks had a rough year in 2022 but have bounced back nicely thanks to economic growth and the excitement around artificial intelligence (AI). Outside of these seven names, the other 493 S&P 500 stocks on average are flat for the year. Much like the energy sector in 2022, if you weren’t invested heavily in large company technology and communication stocks in 2023, your portfolio most likely underperformed. Defensive sectors, including utilities, healthcare, and consumer staples have been the laggards this year. It has not paid to be diversified again this year, but over time diversification has proven to provide strong returns without the risk of putting all your eggs in one basket. Hopefully investors will see broader participation among other sectors as we head into 2024.

As we approach the end of 2023, reflecting on the financial landscape of the past year offers valuable insights and considerations for the road ahead. Despite the challenges faced in 2022, the markets have shown resilience and positive momentum. The interplay of factors such as interest rates, inflation, the labor market, and the standout performance of some technology stocks have shaped investment landscapes. As we navigate uncertainties and opportunities in 2024, your trust and partnership remain the bedrock of our commitment. Our dedicated team is always here to guide you through the complexities of financial planning and investment, ensuring your goals remain at the forefront. We wish you a prosperous and fulfilling year ahead, and we look forward to continuing this journey together.