Fourth Quarter Review of 2023

Fourth Quarter

In my last newsletter, I indicated that uncertainty is no friend to the markets. This bore fruit as October was a dismal month for markets. The uncertainty surrounding a possible increase in FED rates, persistent inflation, and questionable corporate earnings all took a toll on the markets.

The first uncertainty was the FED. While they did not raise rates in September, they indicated that they might do so at their October 31st – November 1st meeting. This is very likely at least once more before year-end. At that meeting, instead of raising rates, they indicated that they would likely not raise rates again. This, in turn, signaled to the markets that the new likelihood was a lowering of rates in 2024.

The second uncertainty was inflation. To put inflation in perspective, it was 7.75% in October 2022. When the inflation rate came out for October 2023 it was 3.24%, down from 3.70% in September. This was another piece of good news for the markets. The drop in the inflation rate continued with a rate of 3.14% in November. This in turn was reflected when the FED met in December and indicated they had penciled in three rate cuts for 2024. A very positive prospect for the markets.

Finally, as the third quarter earnings reports came in from companies, they were mostly either good or above expectations.

Impact on Markets

While others and I were waiting for results during October, markets drifted downward at a rapid rate. From the middle of August, when the S&P was 4582 it was down to 4117 by mid-November. That is over a 10% drop!

Once the answers to our three questions were answered, by mid-November, the markets took off. The stock markets rallied, the bond markets rallied, and it was a good time to be invested in a combination of stocks and bonds, with a measurable reduction in short-term fixed income. In a short span of time, short-term rates have declined by as much as 1%. As rates on bonds fall, the value of bonds goes up.

When the FED was raising rates the value of bonds was declining. Where the Bloomberg Aggregate bond values were down 13% in 2022, by year end 2023 they were up 5.28%.

The S&P500, which had been at 4117 in mid-November was at 4770 by year-end, an increase of 653 points or almost a 16% gain.

This radical change in just six weeks is a clear indication that there are times when you must be in the market to get good results.

Changes That Were Made

Since June we had been waiting to see where things were headed. During most of the year, the best place to have your money was on a very short-term government fixed income. Even with this overweight for many investors, October provided dismal. Generally, changes that we make to investors’ accounts are made during the last quarter of the year. Once we had the answers to where the FED was going with rates, the continued drop in inflation, and an apparent soft landing for the economy. Due to this it was time to make some changes. For our clients, for whom we have discretion over their accounts, we made significant changes in mid-November. For the first time since April 2020, we allocated clients' investments to a strategy that matched their known risk tolerance. This proved fortuitous.

Clarifying the S&P 500

For many years, I’ve used the S&P500 as a proxy for the overall stock market. Unfortunately, the divergence between the overall stock market and the S&P 500 has been reflected in the abysmal results it had in 2022 and the seemingly great gains in 2023. The S&P 500 is a weighted average, which means that stocks with larger values count for more in the average gain or loss than mid-size or smaller stocks. The top stocks, sometimes referred to as the Magnificent 7, Apple, Microsoft, Amazon, Tesla, Meta Platform, NVIDIA, and Alphabet, represent 29% of the average. As a group, these 7 stocks were up 75% in 2023. This meant that the S&P 500 was up, in total, 24% in 2023. When these stocks do well, the index does well, when these stocks do poorly (2022) the index does poorly. If you look at the unweighted S&P500 average, it was up 12% in 2023, like the Dow Jones Industrial Average which was up 13.7 for the year. While the DJIA rose to an all-time high in December, beating its close from January 3, 2022, this was not the case for the S&P500. Its record close of 4796.56 dating back to January 3, 2022, is still the record. The average ended 2023 at 4769.83 at year-end, about a half percent away from that all-time high.

Looking Ahead

As we look ahead to 2024, it would be nice to think that all will be calm and normal. I am sure that will not be the case.

We want to see the inflation rate continue to drop. I believe that the rate changes the FED has made are enough to see this happen. It may not be a straight line down, but the trend should be downward. It will be important for the FED to begin adjusting rates downward during 2024 so the economy doesn’t stagnate or go into recession. This should be a good time for bonds, that have been suffering for the past two years.

The consumer makes up two-thirds of the economy and the willingness to buy is important. With the high FED rate, credit interest rates on home loans, mortgages, auto loans, and credit cards have deterred some consumption. Hopefully, as rates on this retreat, consumers’ outlook will firm up and the economy will be good. As borrowing rates for businesses go down and the ability to refinance current obligations becomes easier, business leaders will be more willing to invest in capital improvements that have been postponed during the past two years.

Are there some looming negatives? Immigration, uncompromising political situations, geopolitical, and various insurgencies around the world, all could have an impact. Let’s hope not!

Ed Mallon