December Market Update
Thanks to expectations of “steep cuts to interest rates” – despite the fact that this could be at odds with the Federal Reserve’s (Fed’s) actual plans – investor optimism increased as 2023 came to a close. The discordance between expectation and reality is not surprising, however, when considering the tumultuous economic and inflation data from 2023. Nonetheless, the market environment looks much brighter at the end of 2023 than it did at the close of 2022.
Larry Adam, Raymond James’ Chief Investment Officer, said, “December’s rally was fueled by a further deceleration in inflation and the Federal Reserve’s switch at the last FOMC (Federal Open Market Committee) meeting of the year to a more dovish tone and talk of Fed interest rate cuts in 2024. However, it is important to put the positive year of performance into perspective: 2023 was a reset year as the over 25% return for the S&P 500 only recouped all the losses from 2022.”
The NASDAQ 100 and leading artificial intelligence stocks saw their best year since the 1999 tech bubble. The S&P 500 ended the year less than 1% from its record highs, and the Dow Jones Industrial Average reached seven all-time highs in 2023. Small-cap equities, despite a low performance all year, were the best performers in the fourth quarter and showed signs of a resurgence.
Despite these achievements, it is likely too soon to start celebrating the Fed creating a “soft landing,” or return to the target inflation rate without a recession. Inflation is still above the 2.0% target. Economic activity remains cooled by the lagging effects of the Fed’s rate hike program. Additionally, inflation can be influenced, and Fed policy can be shaped, by the repercussions of higher economic growth or geopolitical events that disrupt food and energy prices.
Even the most conservative interpretation of the Fed shows a positive outlook for 2024, though: interest rate cuts are likely. The Fed has shown their commitment to reducing inflation, and it seems as if they are turning their attention to the economy.
Before we go any further, let’s take a look at some final numbers for 2023.
Recession Indicated by Composite Index
A composite index for The Conference Board that forecasts turning points in the business cycle, the Leading Economic Index, declined for its 20th consecutive month in November. This was a further weakening than was expected, leading The Conference Board to say that it expects a “short and shallow recession in the first half of 2024.”
Equity Market Growth Forecasted by Movement
The significant performance of a select few high-performing, mega-cap tech stocks propped up headline equity indices through 2023. This led to the idea that the market was stronger than experienced by a more diversified portfolio. By comparison, the average stock has been in a bear market for two years. 2024 could bring more opportunity for these left behind stocks, as recent activity since the start of the October rally suggests positive movement. 10 of the 11 sectors finished in the green in December, and interest-rate-sensitive sectors led the way.
Sentiment Improves and Treasury Yields Lower
The strength of the market through December was shown as fixed income prices soared. The yield on the 5-year Treasury closed in November at 4.27% and ended in December at 3.85%. The 10-year yield decreased to 3.88% from 4.33%. Investors who locked in elevated income levels with the year’s high interest rates saw positive total returns due to the year-ending price strength.
Oil Prices Decrease Due to Waning OPEC+ Vigilance
December saw a return to near 2023 lows in oil prices. Production discipline among the OPEC+ group slipped amid a return to pre-COVID demand. Russia and Saudi Arabia in particular have expressed displeasure with smaller OPEC members that are producing beyond their quota levels, effectively cheating the cartel.
Interest Rates Unchanged in European Central Banks
The Bank of England and the European Central Bank held monetary conditions steady through December, as did the U.S.’s Fed. Meanwhile, the Eurostoxx 600, a composite index of 600 European stocks, hit 23-month highs. Large-cap equities, particularly German stocks, also saw dramatic increases. Despite this, the British and European monetary authorities have not indicated a lowering of interest rates. Investors currently hold a growth outlook, but fears of a long and deep recession due to higher-for-longer rates could rapidly reverse investor sentiment.
Military-to-Military Talks Resumed by the U.S. and China
The 17-month communications impasse between Russia and the United States’ armed forces came to an end in December, as President Joe Biden and President Xi Jinping met. Military-to-military communications can provide a critical avenue for addressing flare-ups and miscommunications around geopolitical flashpoints, such as in the South China Sea and the Taiwan Strait. In light of this, this meeting is generally seen as supporting stability.
The Bottom Line
No one could have predicted the highs and lows of 2023, from an amazing first two quarters, a midsummer reversal, and then a strong end-of-year rally. Strength often begets strength, and due to the progress made on inflation, we are starting 2024 in a much stronger position than we started 2023. However, potential risks remain in sluggish economic growth, a potential recession, and potential changes in investor sentiment. Even when the forecast is clear, this is worth remembering.
Your GDS Wealth Management team is committed to helping you weather whatever 2024 may bring. If you have any questions about any of the content discussed in this market update or about your specific financial plan, please do not hesitate to reach out.
On behalf of all of us here at GDS, we wish you a happy new year full of peace and prosperity.
Investing involves risk, and investors may incur a profit or a loss. All expressions of opinion reflect the judgment of the authors and are subject to change. There is no assurance the trends mentioned will continue or that the forecasts discussed will be realized. Past performance may not be indicative of future results. Economic and market conditions are subject to change. The Dow Jones Industrial Average is an unmanaged index of 30 widely held stocks. The NASDAQ Composite Index is an unmanaged index of all common stocks listed on the NASDAQ National Stock Market. The S&P 500 is an unmanaged index of 500 widely held stocks. The MSCI EAFE (Europe, Australasia and Far East) index is an unmanaged index that is generally considered representative of the international stock market. The Russell 2000 is an unmanaged index of small-cap securities. The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. An investment cannot be made in these indexes. The performance mentioned does not include fees and charges, which would reduce an investor’s returns. International investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. Investing in oil involves special risks, including the potential adverse effects of state and federal regulation and may not be suitable for all investors. U.S. government bonds and Treasury notes are guaranteed by the U.S. government and, if held to maturity, offer a fixed rate of return and guaranteed principal value. U.S. government bonds are issued and guaranteed as to the timely payment of principal and interest by the federal government. Treasury notes are certificates reflecting intermediate-term (2 - 10 years) obligations of the U.S. government. Companies engaged in business related to the technology sector are subject to fierce competition and their products and services may be subject to rapid obsolescence.