Fourth Quarter 2023 Market and Economic Review
What a difference a year can make. This time last year, we were exiting a quarter that started relatively strong, only to end on a sluggish note due to concerns of continued rate hikes by a Federal Reserve determined to curb inflation. The fourth quarter of 2023, conversely, began sluggishly but finished strong on the news that the Fed ceased its series of rate increases and speculation that decreases are not far behind.
2023 has certainly been a year of unease, with multiple factors creating puzzling environments in virtually all investment types. In the U.S., the Fed’s chase to subdue inflation has been successful by most accounts, but there’s lingering concern that a recession awaits if the right levers aren’t pulled with precisely the right amount of pressure.
Such economic pressures and resulting concerns have pushed many investors to seek large and well-known investment opportunities in equities. This migration has created an outsized top-heaviness to the S&P 500 that has never before been experienced. So disproportionate are these stocks that they’ve been called ‘the Magnificent Seven’ stocks and are currently responsible for 29 percent of the S&P 500’s market cap. They include Apple, Alphabet, Microsoft, Amazon, Meta, Tesla, and Nvidia. Additionally, these stocks gained approximately 71 percent over the past year, while the remaining 493 stocks added just 6 percent to the index’s overall growth.
The shift towards these larger stocks has been years in the making but has been hastened this year as economists and investors scrutinized the Fed’s attack on inflation. Mid-year concerns that the Fed had pushed too hard for too long led to poor market performances for much of the summer and early fall months. This period will also be a factor in how the Fed handles the next six months heading into 2024. Most everyone agrees that some rate decreases will be warranted, but if those cuts aren’t handled carefully, it could lead many to point to the middle months of 2023 and declare, ‘I told you so,’ with regard to a pending potential recession.
Handled correctly, though, these rate cuts could spur continued growth in many areas, including in the bond markets and small businesses where other loan rates have already started to come down and create a business-friendly market in recent months.
Another investment segment deserving of close monitoring is U.S. Treasury bonds. The Fed has also been selling off its bonds to reduce its balance sheet, which rose rapidly through Covid. Thus, one question the markets will have for the Fed is when it starts reducing rates, will they also stop selling off bonds and reducing the Fed balance sheet? Presently, Fed Chair Powell views those strategies very separately from each other. However, the economic concern could become, who will buy long-term U.S. bonds?
Is a Recession on the Horizon?
At this point, a recession does not seem imminent and not even particularly likely. Presently, there are more indicators leaning toward a continued growing economy than there are negative indicators.
One key thing to watch that could shift that trajectory (or at least subdue the rate of growth) is consumer behavior, as consumer spending accounts for more than 60 percent of our GDP. Over the past several years, that spending has been a significant part of our economy’s growth. However, much of the savings and federal gifts people accumulated in 2020 are now being depleted. In recent months, there have been slight upticks in personal credit card delinquencies, an increase in late payments of auto loans, and the freeze on student loan repayments has been lifted. The question is, will those realities lead to a substantial drop in consumer spending, or will other segments of the economy recover well enough to keep overall consumer spending steady?
Around the World
From an economic standpoint, the global scene is not much different from the domestic scene when you extract out the war-torn areas of Europe and the Middle East.
Over the past year, emerging markets have increased by 7 percent. By comparison, the equal-weighted S&P 500 is up around 12 percent (remember, there are seven stocks at the very top of this index that are doing most of the work).
In Europe, Asia, and the Far East, markets are up around 17 percent. So, larger, more developed countries are performing better than the smaller emerging markets. Similarly, larger, more substantial companies are outperforming small businesses – a reality that is true both in the U.S. and abroad.
Europe is lagging mostly because it is far more impacted by the conflicts in Ukraine and now Israel and Gaza. Additionally, the European governments provided less financial assistance to their citizens than the U.S. did which has also handicapped their recovery process. Many economists are calculating that Europe is already in a recession, while others are projecting that they will be within the next couple of months.
China is also in the midst of a long-running slowing-growth cycle. The primary drag on their overall economy is the volume of bad debt currently being managed by their banking system in the aftermath of significant infrastructure and real estate investment that stalled in recent years. Essentially, the demand for residential and commercial space has turned out to be significantly less than what was projected 5-10 years ago. Covid interrupted that growth push as the Chinese government enacted very strict living requirements, but most expected a strong return in China’s economy once the restrictions were lifted – a reality that simply hasn’t come to fruition.
Mortgage rates are coming down and should continue to do so very gradually through 2024, providing some much-needed relief to the real estate market. This should also inject some energy into other closely related business sectors, such as home improvements and mortgage refinancing, which have been very stagnant over the past year and a half. Similarly, mergers and acquisitions could also see some uptick in 2024 as rates on those types of business loans are also coming down.
Overall, our forecast is that while overall economic growth will be slow in 2024, there will still be sound investment opportunities in certain sectors as industries respond to their environments. As always, we’ll be keeping a close watch on economic conditions with long-term goals in mind.