The Fed Pivot and a Soft Landing?
2023 Market Recap
Resilience is the term that best encapsulates the overall economy and stock market for 2023. Seemingly impervious to high interest rates, elevated inflation, banking turmoil, political dysfunction in Washington, and growing geopolitical risks, the economy continued to expand at an above-trend pace in 2023. In turn, S&P 500 index concluded the year up +26.29% by rallying +11.69% in the fourth quarter.[1] Global stocks as measured by the MSCI ACWI rose +22.20% for the year and +11.03% for the final quarter of 2023.[2]
Beneath the surface it was a year largely dominated by the top eight tech titans of the S&P 500 that soared 75% as a group in 2023.[3] As of November 1st, the remaining 492 stocks were collectively down for the year.[4] The rally during the final two months of 2023 helped to change the narrative as market gains were extraordinarily broad based. As a result, small-cap stocks as measured by the Russell 2000 Index led the way, rising +14.03% for the quarter.[5]
After the worst bond bear market on record, it appears bonds have finally turned the corner. The Fed kept interest rates unchanged for the third consecutive time at the December meeting. While this news was broadly anticipated, the updated forecast for three rate cuts in 2024 was a welcomed surprise, leading many to believe that the Fed pivot is here.
Overall, it was a wild ride for the bond market as investors grappled with resilient economic data and hawkish Fed. The yield on the 10-year Treasury climbed by nearly 170 bps from early April to late October, before expectations for a soft landing and an end to Fed tightening helped drive the yield lower by more than 100 bps at year end. For the year, the broad-based Bloomberg Barclays U.S. Aggregate Bond Index rose +5.2%, but remarkably the fourth quarter generated all the return for the year.[6] In fact, the final two months were the best two-month rise since 1982.[7]
Positioning for 2024
We enter the new year with our asset allocation framework leaning toward a more favorable posture. The shifting economic narrative appears to have firmly settled in the soft-landing camp. The recession risk appears low, while U.S. economic growth is projected to moderate as inflation and labor market tightness ease, and consumer spending slows. Ultimately, the consumer remains a linchpin of economic activity, and any signs of a retrenchment would alter the narrative. While bank lending standards have remained tight over the past several quarters, potential rate cuts on the horizon should offer some relief. A combination of subdued job growth and slowing wages should give the Fed further confidence that inflation is sustainably coming down and a policy pivot is appropriate.
Overall, the market factors seem poised to maintain their influence and drive positive stock performance for the year ahead. These include the ongoing recognition of disinflation, and expectations of rate cuts by the Fed and other central banks. However, we are mindful that heightened investor optimism could leave the market vulnerable to disappointments. With a Presidential election ahead, history suggests the first half of an election year tends to be weaker until a victor is known. There have been 23 presidential elections since 1928, and the S&P 500 has produced a positive return in 83% of election years, rising by +11.3% on average.[8]
With a Fed pivot likely in 2024, history suggests we have additional rationale to be optimistic. The chart below highlights that historically, stocks are up on average 18 months after the last rate hike, especially in a soft-landing scenario. Looking at the five most recent periods when the Fed concluded a rate hiking cycle, the S&P 500 was up over 12% on average 18 months later.
Technical Market Factors improved tremendously as the fourth quarter progressed. The collection of technical market factors we monitor exhibited renewed strength. It was particularly encouraging when analyzing the breadth of sub-industries, and the marked improvement in better valued areas of the market, such as small caps. While a bout of volatility to start the year would not be unexpected, the drivers of market performance remain in place.
Investor Sentiment rebounded as optimism readings rose from the market pullback experienced between July and October. While sentiment indicators could leave the market susceptible to economic or earnings disappointments, the overall improvement suggests that investor confidence is returning. With inflation receding and the Fed moving toward an easing cycle, any economic or earnings disappointments should be less severe.
Despite the recent bond market rally, the overall level of interest rates is little changed from a year ago. We continue to believe that this is an important period for investors to lean into both public and private fixed income, which remains the most attractive it has been in years. We believe that peak interest rates are likely behind us, and bonds offer the potential for price appreciation when rates decline and defensive characteristics if lower rates were to coincide with a mild recession.
In summary, we enter the year with a defensive tilt relative to our strategic global benchmarks with a modest underweight to stocks. However, given the improving investment landscape, we anticipate the opportunity to increase stock exposure. We believe this is a particularly compelling period to be incorporating a diverse set of private market investment opportunities within long-term portfolios. We expect that 2024 will bring the beginning of the Federal Reserve easing cycle, moderating economic growth, broadening equity market performance, and the benefits of a diversified stock/bond portfolio.
With the start of a new year, we thank you for your continued partnership and for entrusting us as the steward of your family’s wealth. We look forward to health, happiness, and endless possibilities in the coming year!
All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability, or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. The views expressed in this commentary are subject to change based on market and other conditions. These documents may contain certain statements that may be deemed forward‐looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Any projections, market outlooks, or estimates are based upon certain assumptions and should not be construed as indicative of actual events that will occur.
No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. All investments include a risk of loss that clients should be prepared to bear. Different types of investments involve varying degrees of risk and there can be no assurance that any specific investment will either be suitable or profitable for a client’s investment portfolio. Economic factors, market conditions and investment strategies will affect the performance of any portfolio, and there are no assurances that it will match or outperform any benchmark. Asset Allocation may be used in an effort to manage risk and enhance returns. It does not, however, guarantee a profit or protect against loss.
New World Advisors, LLC ("New World") is a Registered Investment Advisor ("RIA") with the U.S. Securities and Exchange Commission (“SEC”). New World provides investment advisory and related services to clients nationally. New World will maintain all applicable notice filings, registrations and licenses as required by the SEC and various state regulators in which New World conducts business. New World renders individualized responses to persons in a particular state only after complying with all regulatory requirements or pursuant to an applicable state exemption or exclusion.
[1] Morningstar Direct
[2] Morningstar Direct
[3] Ned Davis Research
[4] Ned Davis Research
[5] Morningstar Direct
[6] Morningstar Direct
[7] Ned Davis Research
[8] Morningstar/Ibbotson Associates