|Thayer Commentary – Five Key Questions
What happened in the financial markets in the fourth quarter and full year 2023?
A topsy turvy year ended on a strong note, thanks to a very good closing kick in November and December. Bonds rallied sharply from what had been a slightly negative year to date late October position, and historic drop in 2022. Measured by the inclusive U.S. Aggregate (AGG) index, bonds posted a 6.8% fourth quarter gain, bringing the year to +5.7%, thus offsetting part of their 13.0% loss in 2022. Stocks also surged, essentially erasing their big 2022 losses. The All-Country World Index (ACWI) gained 11.0% and 21.2% in the quarter and year, the latter figure almost making up for an 18.2% 2022 drop.
U.S. stocks led the world, courtesy most notably of large technology-driven names. The S&P 500 enjoyed an 11.7% fourth quarter rise, bringing the year to up 26.6%, more than offsetting 2022’s 18.2% loss by a few percentage points. The NASDAQ index surged by 44.6% in 2023, powered by the “Fab 7” group – NVIDEA up 239.0%, Meta 194.0%, Tesla 101.7%, Amazon 80.9%, Alphabet 58.3%, Microsoft 58.2%, and Apple 49.0%. The Dow index gained more sedately at 16.2% for the year but did outgain the S&P in the quarter (up 13.1% vs. the S&P’s +11.7%). Meanwhile, non-U.S. developed markets and emerging markets posted respective 18.2% and 9.2% gains for 2023. Japanese and continental European markets were competitive with the US, while the UK and China were flat, and Hong Kong was negative.
Not surprisingly, there was a wide range among U.S. industry sector returns. Technology (up 57.8%), communication services (up 55.8%) and consumer discretionary (up 42.4%), lifted by the Fab 7, were dominant, while the health care (up 2.1%), consumer staples (up 0.5%) and energy (-1.3%) sectors were on the outside looking in. As was the case broadly, much of this was a mirror image of 2022, which had seen major losses, effectively downside leadership, from technology-oriented stocks.
How did Jay Powell’s inflation campaign and late-year perceived pivot affect markets?
Market psychology turned on attitudes about inflation and perceptions about the Federal Reserve Bank’s policy body language. Successive Consumer Price Index reports for October and November proved to be surprisingly benign, indicating continued improvement from 2022 highs as well as a stronger possibility that the Fed would succeed in approaching if not reaching its 2% goal.
After a 15-month policy rate hike campaign from effectively zero to 5.25-5.50% by July 2023, not only have we paused, but hopes have risen for monetary easing this year, a pivot to rate cuts. Perhaps most importantly, Chair Powell added confirmation of 2024 rate cut plans at the December 13th Fed meeting, on the order of possibly three quarter-point moves. Treasury rates eased both before and after the meeting, the ten-year falling more than a full point from 5.0% in late October to 3.9% at year-end, almost exactly where it had started 2023.
The sense of impending victory over inflation was paired with robust economic readings, a welcome and hitherto unexpected combination. This included third quarter GDP just under a strong 5% and unemployment staying under 4%. Recession forecasts thus have been pushed out, a stark contrast from consensus forecasts a year ago for this to happen by the end of 2023. Indeed, the Fed has been receiving improved grades for its work on both sides of its dual mandate — price stability and full employment.
Is a soft landing with rate cuts the likeliest scenario for 2024?
Looking to 2024, a recession continues to not look imminent to us. However, it is very likely that we’ll see a deceleration from the 5% GDP clip that we enjoyed last fall, perhaps closer to the 2% area. Importantly, the lagged effects of restrictive Fed policy will continue to work their way through the economy. This will include not only higher interest rates for new home buyers but also adjustable-rate resets (usually capped at 2%) among current mortgage holders. This could crimp consumer spending, which to now has been a key pillar under the economy’s surprising resilience.
Also, job and wage gains, which have most directly supported consumer spending, are encountering some headwinds. While job growth has remained reasonably healthy, by some measures still ahead of where we were just before the pandemic, it has cooled measurably, from around a million new jobs per quarter a year ago to about half that more recently. And looking more closely, most of the recent gains have come from only a handful of sectors, chiefly health care and education, with only nominal gains in transportation, leisure and hospitality, the latter group more sensitive to discretionary consumer spending. Commensurately, overall wage growth has begun to cool as well, from around 5% a year ago to about 4% today.
This cooldown may indeed presage a Fed pivot to cuts this year. And, as with the rest of us, Powell is wary of other threats to economic equilibrium. This includes geopolitical disruptions from an almost two year old stalemated war in Ukraine now joined by the three month old Israel-Gaza conflict. Neither appears close to resolution, and both carry contagion risk and potentially heightened carry-through strife between and among larger world powers. Supply chains, having settled in the wake of the COVID reopening and initial Russian invasion, could well face new threats.
How might the U.S. election and other major elections impact markets in 2024?
The U.S. presidential election is sure to weigh on all investors’ minds this year, with countless permutations to sort through. And we’re not alone: by at least one count (Time magazine), 64 countries and 49% of the world’s population will head to the polls this year. And while not all elections will be free and fair, even Russia’s March tally might tell us something about attitudes toward Vladimir Putin, as the massive losses of soldiers, civilians, and resources in Ukraine enter a third year. Taiwan kicks things off in mid-January, and a win by the favored Democratic Progressive Party could well darken Chinese views of the self-governed island. Meanwhile, U.K. Prime Minister Rishi Sunak is expected to call for a general election some time this year, India votes in May, and Mexico votes in June.
While our election is ten months away from this writing, the next few months are important, as they should remove all doubts about the match-up. Gauging Biden vs. Trump, markets will game out implications for Jay Powell’s future, tax policy including whether to renew or alter the 2017 Trump tax cuts in 2025, trade policy (which has not meaningfully changed from Trump to Biden other than renewing partnerships), handling of the border crisis and immigration policy, and approaches to the two wars, among many other key issues. As markets prefer knowledge, even adverse, to uncertainty, it will be helpful to resolve the elections, and, one would think, extremely critical to avoid any doubts after votes are taken.
What is Thayer’s portfolio positioning heading into 2024, any changes, and why?
Thayer client portfolios have over past months transitioned toward traditional, and low-cost, equity and bond exposure, with less reliance on (somewhat more esoteric and expensive) alternative mutual funds. Portfolios participated well in the late-year rallies in both stocks and bonds.
Now, as 2024 begins, we are making only a minor change. Within the bond book, we are modestly lengthening the blended maturity of the underlying holdings, by trimming two short term funds and adding to a longer-term fund. On a backdrop of expected slowing economic growth and lower consumer spending, bringing the possibility of Federal Reserve policy rate cuts, we want to better capture any attendant lift of bond prices, which could most directly advantage longer maturities (or “duration”).
Within the equity book, we maintain a moderate bias toward US stocks as well as a slight underweight to higher priced technology stocks. Following their year-end rally, stocks are more fully priced, and we want to tilt a bit toward names that were not part of the Fab 7 wave. Given that stocks overall are about where they were two years ago after the offsetting 2022 and 2023, we do not consider them unduly expensive. Further, for now at least, valuations are reasonably well supported by a healthy earnings outlook. As always, this is a long game, and while 2024 will pose challenges, it will be important to maintain discipline amidst the noise.
Thank you for your trust in us, and our very best to you in the new year.
David Miller | Miller CPA, LLC & Chris Wilmerding | Thayer Partners, LLC
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