As we head into 2024, it’s noteworthy just how much sentiment has changed compared to this time last year. The beginning of 2023 was plagued with expectations that rising interest rates would lead to higher unemployment and a slowdown in the economy, eventually triggering a recession. Instead, the labor market continued to add jobs and consumer spending remained surprisingly resilient in the face of higher prices, all while inflation continued its downward trend. Throughout the year, investors grew more confident that the Federal Reserve would be able to guide inflation down without causing a recession (i.e. “soft landing”). Those expectations were boosted during the fourth quarter when the Fed indicated that peak interest rates have likely been reached, and that rate cuts were now being considered for 2024. Both stocks and bonds rallied in response to the Fed’s policy pivot, and financial markets ended 2023 on a high note.
The S&P 500 rose 11.7% during the fourth quarter, bringing the total return for 2023 to 26.3%. The index is now slightly below the all-time high it reached at the beginning of 2022. While just a handful of mega-cap technology stocks were responsible for a significant portion of market gains during the year, the fourth quarter featured broader market participation among U.S. stocks overall. This was especially seen within mid- and small-cap stocks, which outperformed their large-cap peers after underperforming for most of the year. The bond market experienced an impressive rally as well, with the Bloomberg U.S. Aggregate Bond Index rising 6.8% during the quarter, bringing the benchmark’s total return to 5.5% for the year. The yield on the 10-year treasury peaked at 5% in mid-October before ending the year below 4%, a quick reversal that was set in motion when the Fed began to signal that its rate-hiking campaign had come to an end.
Inflation and the direction of monetary policy were dominant themes for financial markets throughout 2023, with the Fed’s pivot toward policy easing marking a major turning point during the fourth quarter. With substantial progress on inflation already achieved, and the downward trend expected to continue, the focus is turning toward preventing an unnecessary decline in economic growth through interest rate cuts. Investors have shifted their attention to the timing and extent of rate cuts in 2024 and are currently forecasting six quarter-point reductions this year, above the Fed’s own projection of three. Nevertheless, a slowdown in the economy is expected relative to last year. While the markets have embraced a soft-landing scenario, we believe it’s still too early to declare victory over inflation. The next few months of economic data will be critical in this regard, providing more clarity on the timing and magnitude of policy easing over the course of the year ahead.
After staging an impressive recovery last year, the market is entering 2024 at an important juncture. Strong earnings will need to validate the market rebound given the higher valuations we’re seeing today, especially for companies whose stock prices have been driven by enthusiasm in trending themes such as artificial intelligence. The lagged impact of higher interest rates on the economy will continue to be a major focus of ours, with risks remaining despite the market’s optimism for a soft landing. Furthermore, recent geopolitical events and the upcoming U.S. presidential election will increasingly be top of mind as the year progresses. Taking these factors into consideration, we continue to favor high-quality companies within both equities and fixed income, while staying diversified across asset classes and rebalancing when opportunities arise.
As always, please do not hesitate to reach out to us with any questions. We wish you all the best in 2024.