Sideways markets, wars, inflation, new market highs, a Santa Claus rally, the upcoming election…join Cassie Laymon and Hillary Sunderland as they look back at the markets and economy in 2023 and discuss our outlook for 2024.
Full transcript below.
Hillary, Happy New Year.
Happy New Year, Cassie.
I am pretty excited for 2024 and what lies ahead. But today we’re going to talk a little bit, well, I’m going to give a teaser. We’re going to talk a little bit about what happened in 2023, and of course everyone wants to know what you think about for 2024. That’s going to come a little bit later, just giving them a heads up.
So I thought maybe you could just start off by telling us a little bit about your thoughts about the markets and the economy in 2023. What’s your recap?
Well, 2023 was a particularly difficult one for investors because the markets moved sideways for most of the year, and that’s because we faced really a slew of contradictions. Inflation was easing, but the labor market cold. Another war broke out in the Middle East. We had a few bank failures in the spring, and yet the Federal Reserve kept pushing interest rate higher and that led to a lot of volatility in both the stock and the bond markets. And they moved sideways because there was a fear that the Fed would keep interest rates too high for too long and tip the economy into recession. But what happened during the fourth quarter is that the Federal Reserve indicated that interest rate cuts could be on the horizon, and this was a dramatic shift in their tone concerning interest rates. And it led to a furious rally in both stocks and bonds.
So by the end of the year, almost all major asset classes exhibited positive returns. So as you can see on this chart, US large cap stocks led the rebound and returned almost 27% closing the year within a whisker of their all time high.
Small cap and mid cap stocks broke out of their sideways trading range as well, returning almost 17%. Outside of the U.S. both international and emerging market stocks rose at a healthy clip and as was our expectations, once the Fed changed their stance on interest rates, bonds rallied with both global bond market and the US investment grade market returning about five and a half to 6% as investors were very comforted by the Fed’s tone on the shift in interest rates. So we had a really, really nice rally into year end, which is great. The only major asset class that was down in 2023 was commodities, partly due to weaker demand from China.
You know what I found so interesting, Hillary, not too long ago, just a couple of weeks ago, we did this Q&A about investor fatigue and we were all feeling it like almost two years of sideways markets and people are getting to the point where they’re like, I can’t take it anymore. And it’s so interesting. There’s graphs. We can show that when people get to that point is just when things start to turn. And that seems like it was exactly what happened. So that is just a message to people, I think, to stay invested even when you’re feeling frustrated. So it was really interesting to see that play out. Alright, so what was your biggest surprise of 2023?
Well, there were a few surprises in 2023. So when you look back historically, there’s often a defining theme in the markets for a given year. In 2020 was the pandemic, 2021 supply chain issues, 2022 was rampant inflation. I would say 2023 was really the year of artificial intelligence.
And so a lot of the market advance, especially early in the year, was focused just on a few key stocks in the market, Apple, Alphabet, Microsoft, Nvidia, and those drove a lot of the market returns this year. I actually have a chart just to show you how strong the advance was in just a few of those stocks.
Now this actually shows the top 10 holdings of the S&P 500, but what you can see here is that the top 10 stocks in 2023 accounted for whopping 86% of the returns of the index. And while those stocks are currently trading at lofty valuations, what you can see is that the remaining stocks in the index only accounted for about 14% of the return and they are still trading at a discount.
And so what that means is that going into 2024, although we are right at a key point in the markets in that we’re testing an all time high for the S&P 500, when you look underneath the surface, there is still a lot of value that we find in the index that can add a lot of incremental returns as we look ahead.
The other thing that surprised me, I’m sorry.
I was just going to say the other thing that surprised me about 2023 was that heading into the year, our base case scenario was that while inflationary pressures would come down toward the historical average, which they did, we thought that the economy would tip into a recession because the Federal Reserve was really holding interest rates high, which we felt was for too long of a period of time.
But that did not happen. The economy was remarkably resilient. Unemployment is still sitting in about 3.7%, so we are not seeing that tick up an unemployment rate at all. Real GDP growth has been above trend for five consecutive quarters. So we’ve had a very resilient economy, which was quite the shock in 2023.
Well, you sound pretty optimistic.
Well, in terms of our outlook for 2024 in terms of the economy, while we’ve had some robust quarters recently, there are indications that the economy is decelerating, which should keep the Fed on hold with interest rates at least for the first half of 2024. We think they may start to cut interest rates in the latter half of the year. We do expect economic growth is slow and inflation to continue to abate, but there’s a lot of potential risks on the horizon as well.
It is an election year, so probably 2024, the theme of the year will be the election. We also have the lagged consequences of higher interest rates and some very significant geopolitical tensions, especially in the Middle East and in Europe and with China that continue. So our base case is that in 2024, we do think the economy will slow. The Fed’s recent take on interest rates hopefully will keep us out of a recessionary scenario in the year ahead, but were kind of teetering on that line.
So Hillary, I know you’ve talked about this before, but can you just remind us about how markets typically respond in an election year?
That’s a great question, Cassie. So typically in an election year, there’s some volatility leading up to the election, but if you actually look historically and you’re a student of the market, what you’ll find is that the market moves shortly after election aren’t really that contingent upon which party wins the election.
The market actually tends to do well when we have a divided Congress because one party can keep the other party in check. But historically speaking, there’s really no precedence for if this party wins the election, then this will happen. It’s very much a toss up. I would always like to say that the outcome of election and what impact it has on the market is really just what policies actually get enacted. And as you know, people talk a lot heading up to election about what they’re going to do in office and rarely does it actually come to pass. And so it’s really difficult to make predictions based on the outcome of any particular election.
So would you say that once the election is over and some of the positives that typically happen in the market is just the certainty, right, that it’s over and we know what to expect?
Exactly, yes. The market hates uncertainty, as do we all, right. That was one of the other themes of 2023. Just a lot of uncertainty on the horizon.
So I would say the best thing for investors to do is really just stay the course and remember that the markets have done well, regardless of which political party is in office, and you’re invested in companies that create essential goods and services that people globally rely on. And because of that, most companies should continue to do well regardless over the long term, regardless of which political party gets into office.
Great. Is there anything else you would add for us today?
Just a quick outlook on just the markets as well, on the fixed income side. So I know in 2022, a lot of investors, myself included, were very frustrated with bond returns. What we do see right now is that interest rate volatility should continue to subside and give some much desired stability in bonds. All things considered, I think bond investors should prepare for brighter days ahead, both in terms of the income they’re receiving on their investments and capital appreciation. Once the Fed starts cutting interest rates in 2024, that’s good for bond investors. And that’s regardless of whether the economy has more of a soft landing or if we actually do go into recessionary scenario, given current yields. I think holding cash on the sidelines instead of investing in bonds will be very costly for investors in 2024 because cash yields have likely already peaked for this cycle.
And then in terms of the equity side of the market, the S&P 500 right at the end of the year was testing its all time high. A lot of that due to concentration of performance just in a few names, but anytime you get to that key technical level as well as coming right off what we call a Santa Claus rally, the last few days of a calendar year tend to be some of the best for the markets. I do think you’ll probably see some profit taking earlier in the year, early in January, especially in large cap stocks. But if you look across the broad opportunity set, remember that we are global investors. There’s still a lot of value in small mid-cap stocks. International stocks are trading at very good valuations, and so we’re positioning portfolios to where we see a lot of value in the year ahead.
Great. Well, thank you for sharing all that with us. I know nobody has a crystal ball, and so we just make some predictions based on what you’re seeing in the markets and the economy. So it’s always fun to kind of look through the year and see how it all plays out.
Well thanks Cassie, and thank you all of our clients for being valued clients of ours. I wish you a happy New Year.
Yes. And if you want to talk about this any further, please reach out to your advisor and we’re happy to answer any questions that you might have. Happy New Year, everyone.