Q4 2023 US Market Review & Outlook
At the start of the year, Wall Street strategists were predicting 2023 would see a recession and we would experience a tough year for stocks and bonds. We are glad that the experts missed the mark! The year's final quarter saw a strong rally across all asset classes, capping an excellent year for the markets. The S&P 500 is now just 0.6% below its all-time high from January 2022.
This quarter's rally was fueled by the Federal Reserve (Fed) signaling an end to their interest rate hikes, with cuts expected in 2024. Interest rates on 10-year government bonds peaked around 5% in October and closed the year at 3.8%. The economy has performed well despite the most aggressive hikes in a generation. A stronger economy can be chalked up to a solid jobs market, inflation trending lower, and a consumer that continues to spend.
While stocks did end the year on a strong note, the market rally was uneven. About 70% of the stocks in the S&P 500 did not beat the index for the year. This is the second-highest rate since 1980. This means that this year's rally was concentrated in just a few companies. The “Magnificent Seven” (Amazon, Apple, Alphabet (Google), Nvidia, Meta (Facebook), Microsoft, and Tesla) represented almost 30% of the market and were responsible for about 22% of the 26% rally in the S&P 500.
Investment Strategy
During the quarter, we made some updates to your investment strategy. We removed our overweight allocation in US small-cap stocks. Your portfolio is currently invested in line with your core investment strategy, meaning we do not have any over or underweight tilts in your portfolio. In addition to this strategy update, we also changed the holdings for your international stock investments. We added the Vanguard Developed Market ETF to your portfolio. This change provided a broad-based and low-cost exposure to global developed markets. We sold your international low volatility and momentum ETFs to make way for this new holding.
Outlook
2024 is shaping up to be a choose-your-own adventure for things to worry about in the markets. There are presidential elections, a war in the Middle East, slowing economic growth, and a pessimistic consumer. This is just a short list! Regardless of current events there are always concerns to monitor that could cause us to alter your investment holdings in the near term while minding your long-term investment plans. We are optimistic that 2024 will be another positive year for the stock and bond markets despite the expected challenges and unknowns ahead.
At the Fed’s December policy meeting, they signaled their plan to cut rates in 2024 for the first time since March 2020. The end of interest rate hikes and a return to normalizing monetary policy is a positive for the markets. The Fed is projecting they could cut rates three times in 2024 by a total of 0.75%. The market is more optimistically projecting five cuts (between 1.25% and 1.5%). By announcing their intention to cut rates next year, the Fed feels it has done enough to bring inflation lower and can focus on keeping the business cycle healthy.
The outlook for stocks looks positive in the year ahead. Earnings growth for 2024 is expected to be around 10% for larger companies and above 20% for smaller companies. This should be the biggest driver for stocks. Another positive catalyst for stocks is the large level of cash being held by corporations as well as individual investors. Companies may be more interested in making acquisitions or buying back their own stock. Interest rate stability will give companies an opportunity to deploy cash on their balance sheets. Money market funds are holding over $6 trillion in assets, much of which has flowed in over the past two years. Individual investors may start to move money out of money market funds and back into the markets as interest rates start to drift lower. We believe individual investors may be enticed by fantastic returns in stocks that they may have missed last year as they continued to hoard cash. While we are optimistic about stocks, valuations are a little rich, which may prevent stocks from having an above-average year like 2023.
The bond rally in the fourth quarter took some upside away from future returns but bonds still look attractive at current yields. Three months ago, bonds presented the most enticing opportunity since the 2008 financial crisis. Yields still look good, although our expectations are that bonds should offer between 4% and 6% total returns in the year ahead. This is in line with long-term average returns. We will gladly take an average-looking year after the roller coaster ride we experienced over the past three years.
The presidential election will dominate much of the headlines in the year ahead. We have written extensively about how stocks perform in election years. Our advice is to separate politics from your investment decisions. Elections can play a role in investment outcomes, but remember, corporate earnings and economic growth are the real heavyweights driving returns.
Andrew Comstock, CFA