Economic & Market Insights: Reflecting on 2023 and Looking Forward to 2024
A Resilient Economy
At the beginning of last year, most economists and strategists were confident that the U.S. would enter into a recession in 2023. Many traditional indicators of a recession, such as the inversion of the yield curve, supported this conviction. Multiple interest rate cuts were expected but did not materialize as the Federal Reserve (Fed) continued its hiking campaign throughout the year, even as the collapse of Silicon Valley Bank threatened a broader crisis. The U.S. experienced strong economic growth, buoyed by consumers who refused to slow down despite multiple headwinds, such as tightening credit standards, resuming student loan payments, and decreasing excess savings. Stocks finished the year up more than twice the average return, and bonds saw a strong finish as rates likely peaked for this cycle.
Our Insights:
The U.S. economy, primarily powered by consumer spending, is resilient. Economists’ predictions of low growth, higher unemployment, and sticky inflation in 2023 were proven incorrect as unemployment remains low, growth is strong, and inflation appears to be near the Fed’s target. As long as consumers continue to spend, it is unlikely the U.S. will see a meaningful increase in unemployment, which should stave off a recession.
Companies, particularly on the small end of the spectrum, may get squeezed by higher refinancing costs as we move into 2024. The market may have priced in that possibility in 2023, as small companies were some of the worst performers for most of the year. However, if the Fed cuts rates as the market expects, firms may escape additional pain, reducing the likelihood of any broad market impact. The Fed is well aware of historical episodes that saw an inflation reacceleration following rate cuts. We believe Fed Chair Jerome Powell will be prudent in his approach to rate cuts as he seeks to pull off the fabled soft landing and cement his place on the Mount Rushmore of Fed Chairs.
U.S. Equities
Despite entering the year with many experts predicting a recession, U.S. stocks, as measured by the S&P 500, finished 2023 up 26%. The market was powered higher by seven of the largest stocks, which have come to be known as the Magnificent Seven and include Alphabet, Amazon, Apple, Microsoft, Meta Platforms, Nvidia, and Tesla. Many have used this fact to point to the “bad breadth” of the market, as only a small group has been responsible for most of the gains. Encouragingly, we saw the rest of the market begin to catch up over the last few months, with the S&P 500 Equal Weight Index finishing 2023 up 12%.
Our Insights:
While it’s true that several large stocks were responsible for most of the gains in 2023, we don’t believe investors should lean solely on this reality to justify their allocation decisions. At Blue Trust, our data-informed investment process utilizes short-term, tactical indicators like current economic conditions and long-term, strategic indicators like gross domestic product (GDP) growth. In the short term, U.S. equities still appear expensive relative to other developed market peers. However, the U.S. may deserve such a premium, as it boasts some of the largest and most influential companies backed by, arguably, the world’s most diverse and resilient economy.
Emerging Markets
Emerging markets (EM) have also shown resilience in the face of tighter monetary policy, higher food and energy costs, and shifting supply chains. China has been the largest drag on performance as it deals with problems in its property sector, supply chain realignment, and secular issues arising from an aging population.
Our Insights:
While China is struggling, other EM countries, like India and Mexico, are benefiting from foreign investment as companies look to move production to more favorable parts of the world. We believe active management is particularly attractive in EM and can provide diversification versus the benchmark index that China currently dominates. Projections of strong earnings growth, bolstered by younger, faster-growing populations, continue to make EM an attractive place to invest. You can read our recent analysis on EM here.
Fixed Income
It’s been a roller coaster ride for fixed-income investors over the last several years. The bond bull market that began in the 1980s came to an end in the post-Covid era. Bonds were on track for a third consecutive year of losses but finished higher for the year after a strong rally at the end of 2023.
Our Insights:
After the U.S. Treasury surprised the market over the summer by announcing larger bond sales than anticipated, the bond sell-off accelerated into the fall as investors worried that the Treasury would flood the market with supply once again. Since yields and prices are inversely related, bonds fell as yields rose in anticipation of the fall announcement. Other factors, such as the U.S. credit rating downgrade by Fitch and stronger than expected GDP growth, also contributed to the spike in yields.
After the bond supply announcement came in below expectations, bonds were off to the races and didn’t look back. If an investor went to sleep at the beginning of 2023, they would have awoken to yields in December that were virtually unchanged from a year ago. Going forward, we believe bonds still play an important role in a diversified portfolio. The low interest rates investors saw for more than a decade were not typical, and rates are now consistent with long-term averages and productive economic expansion. While higher rates have allowed investors to earn attractive yields on cash equivalents, we want to ensure investors understand the trade-offs and risks. You can find our detailed thoughts on cash equivalents here.
Real Estate
The housing market held up remarkably well in the face of rising mortgage rates, which peaked near 8% in the fall. More flexible work arrangements and millennials entering their prime family formation years have led to steady housing demand in recent years. Initially supported by low interest rates, constrained supply has continued to support prices. Most of the pain has been felt in the commercial real estate market. Office buildings have been impacted the most as companies grapple with changing employee preferences, such as the desire to work remotely.
Our Insights:
Although, by some metrics, housing activity is at levels last seen during the Great Financial Crisis, we don’t think investors should be alarmed. Home prices have increased due to low inventory brought on by a decade of underbuilding. As builders rush to meet demand, prices should stabilize or decline slightly as new inventory becomes available. If the Fed delivers rate cuts as expected, this will likely lead to a spike in housing activity as owners look to refinance and buyers receive relief on financing. If the Fed does begin a cutting cycle, we believe it will be important to watch for a potential increase in inflation due to a resurgence in housing activity.
Many articles citing redemption gates in private markets have spooked investors this year. While our solutions have limited exposure to commercial real estate, we believe it is important for investors to remember private funds are inherently illiquid. Therefore, investors should never lock up money they will need to meet short-term needs. You can read our detailed thoughts on commercial real estate here.
Commodities and Gold
Gold performed well in the fourth quarter. The Israel-Hamas conflict and the prospect of easier monetary conditions supported the metal, though many commodities lagged. This trend is consistent with previous episodes, like last year’s banking crisis, that have seen a “flight to safety” trade in gold when market turmoil spiked. Commodities finished the year down nearly 8% as a sluggish Chinese economy led to reduced demand and markets adjusted to disruptions from the conflicts overseas.
Our Insights:
We continue to monitor market conditions, Fed policy, and inflation trends to help determine the best time to allocate investment dollars to commodities and gold. Even as gold prices spiked in the last part of 2023, we capitalized on these returns with our exposure during the first half of the year.
Similarly, we captured much of the strong commodities’ gains during the inflationary spike of recent years. We exited our commodities exposure as it appeared inflation had peaked, and supply chains were starting to heal. You can find our detailed thoughts on gold here, as well as our comments on Israel and potential implications for oil prices here.
Election
Many believe 2024 will be the most significant election year in history, as dozens of elections occur worldwide. With more than 60 countries heading to the polls, election headlines will most likely dominate the news cycle this year. In the U.S. key political events are upon the horizon with the Iowa GOP caucus and New Hampshire primary both taking place in January, followed by the South Carolina and Michigan primaries in February.
Our Insights:
The headlines this year will clamor for our attention, but it is important to remember that the election results will most likely not impact market prices in the long term. How will the election impact the market in 2024? Since World War II, only two election years have seen negative returns. Since the S&P 500 Index began, 20 of 24 election years saw positive performance.
As with any investment strategy, there is potential for profit as well as the possibility of loss. Blue Trust does not guarantee any minimum level of investment performance or the success of any investment strategy. All investments involve risk and investment recommendations will not always be profitable. Diversification does not guarantee investment returns and does not eliminate loss. Past performance does not guarantee future results.
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