Market Performance in Late 2023

To say that the markets finished 2023 on a strong note would be an understatement.

Most of the year saw gains driven by a few mega-cap stocks, but that shifted in early November.

Investors began to gain confidence that the Fed had indeed finished raising rates.

Key Index Performances

The markets surged in the final stretch of the year. The S&P 500 surged 15.8% from its October 27 low into year-end, bringing its 2023 gain to 26.3% on a total return basis. Gains were extraordinarily broad-based:

• The Russell 2000 Index (small caps), which had been negative on the year through October, surged 22% to finish up 16.84% for the year.
• The Nasdaq Composite led the way, gaining 43.4% in 2023.
• Overseas, the MSCI EAFE Index jumped 16.2%, while the MSCI Emerging Market Index gained 9.9%.
• Even cash had its best returns in decades, with T-bills returning 5.2%, the highest since 2000.

Commodities were the biggest losers, with the S&P GSCI falling 12.2% due to a sharp drop in crude prices in Q4.

Recovery from 2022 Losses

While global equity markets posted healthy gains in 2023, it’s important to note that most indices were merely clawing back losses sustained in 2022.

• Even after the headline-grabbing 43.4% return for the Nasdaq, the index remained down 3% nominally over the past two years, following a 33% decline in 2022.
• The incredible 300+% return on Bitcoin left the asset essentially flat over the two-year timeline, given its 75% decline in 2022.
• Other major indices also reflected losses on their two-year returns, including the Russell 2000, which was down 6.97%.
• The S&P 500 was up marginally over the past 24 months, squeaking out a gain of 3.42%.

This underscores the importance of viewing the markets through a longer-term lens, rather than focusing solely on single-year performance.

Fed Rate Hikes and Market Optimism

Optimism that the Fed may finally be finished raising rates fueled the late year run in equities.

While the Fed had been saying for months that investors shouldn’t expect rate cuts anytime soon, its tone seemed to shift after the last Federal Open Market Committee meeting in December.

They now suggest that there could be three rate cuts in 2024, although the market has quickly priced in more than that. This new posture from the Fed aligns with the easing inflation pressures observed globally during 2023, removing a burden on macroeconomic growth.

With inflation steadily improving from its June 2022 peak, it seems the Fed should be able to “give back” some of its rate hikes.

Looking Ahead: Economic Outlook

Easing inflation and potential Fed rate cuts are fueling hopes for a soft landing over a recession. Analysts expect this to support earnings growth and further stock market gains.

However, leading indicators still point to slowing economic growth, and it remains to be seen if a soft landing is achievable.

Market Pricing and Risks

While the odds of a soft landing have increased, markets appear to be already pricing in that scenario, leaving little room for significant further gains.

• The S&P’s forward P/E ratio (price divided by consensus earnings expectations) is in historically high territory, having gained 5.5 points since its low of 15.3 in October 2022. This increase has been driven by anticipation of an earnings recovery, which is now occurring. However, if earnings continue to grow, the impact on stock prices could be muted by falling P/E ratios.

Another risk is that the Fed may need to walk back its narrative of rate cuts. Even if the Fed manages to achieve a soft landing, pivoting to rate cuts too soon could threaten its progress in bringing core inflation closer to its target zone.

Lastly, there’s the risk that the soft-landing scenario may be incorrect.

The interest rate shock over the past 18 months could negatively impact economic activity and broad equity markets. Geopolitical developments present additional challenges, affecting commodity prices, inflation, global trade in goods and services, and financial flows.

As always, we continue to monitor the progress of the market and make adjustments accordingly.

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