After a volatile 2022 which saw bear markets in both bond and equity markets, 2023 was a bright spot given all the uncertainty overhanging the markets and economy. Despite a banking crisis in March, geopolitical uncertainty, and inflation still looming over consumers’ heads, nearly all asset classes ended positive for the year, notably the S&P 500 returning over 24%. The commentary by the Federal Reserve in December alluding to a potential policy pivot in 2024 supercharged markets in the last quarter, with smaller companies leading the way.
The seven major stocks, “the Magnificent 7”, expanded their dominance over the S&P 500 and now make up 28% of the index. With a median return of 81% for the Magnificent 7, valuations are still reasonable given the earnings power of these companies. Thankfully, we have seen some breadth return to the markets after the Fed’s December commentary, leading to a healthier recovery. Bond markets have also stabilized, with the 10-year yield falling from nearly 5% in October to less than 4% in December, providing much-needed relief to lending for consumers and businesses.
Contrary to predictions of economic challenges, 2023 surprised many and proved resilient. Unemployment has remained low at 3.7%, while inflation has fallen to 3.1% over 12 months. While weak spots are appearing in the current “higher rates for longer” regime, consumers continue to spend, leading to above-average growth in the U.S. economy. Housing remains a focal point as affordability is the worst it has been in 40 years due to higher rates and a persistent supply/demand imbalance.
While the markets are largely optimistic about the speed of rate cuts coming in 2024, we remain cautious due to lingering inflation. Expectations include slower growth and a weakening job market in the first half of the year, with hopes for a shift to easing policies in the second half. The goal is a soft landing for the U.S. economy in 2024/2025, barring unexpected events. Globally, Europe is facing a potential recession, and Emerging Markets struggle with high debt, potentially prompting other central banks to ease rates.
Diversification remains paramount. As we progress through 2024, the dominance of mega-cap stocks is expected to change. Earnings are expected to recover, providing a tailwind to asset classes that were largely left behind in 2023, namely small caps and value stocks. Bond markets also offer opportunities not seen in over a decade to lock in higher yields for extended time frames.
Cash and money market yields have been a haven for nervous investors over the last two years, but keep in mind this can change quickly as rates are cut. Utilizing these vehicles for short-term savings is recommended, but excess cash and savings should be invested for the long-term as these short-term rates will fall once rate cuts commence. Consistently investing excess funds over time into the stock and bond markets will help ensure participation in the next expansion phase of the economy.
Maintaining a long-term perspective on your investments will help avoid emotionally driven decisions brought about by headlines. We encourage you to speak with your Financial Services Representative to review your goals to ensure we have the best allocation possible for you and your family.