Quarterly Commentary

4Q 2023

Last year’s markets behaved as usual by defying expectations at every turn. Investors were taught yet again that the economy and markets are inherently unpredictable.

It is understandable that investors started the year in a downbeat mood, given the miserable stock and bond returns of 2022. Many doubted that the Federal Reserve could orchestrate a “soft landing” – conquering inflation without beating up the economy. History is littered with failed attempts, either the Federal Reserve over-tightening and pushing the economy into recession, or the Fed under-tightening, resulting in resurgent inflation.

It took nearly the entire year, but in the end, a soft landing was in sight. There were tough moments along the way – notably the regional bank scare that raised visions of fleeing depositors, as well as a summer sell-off as the Fed vowed to keep rates “higher for longer.” This second episode, which stretched from the beginning of August through the end of October, looks in hindsight like a textbook market correction. Both stocks and bonds fell 10% or more as fears overwhelmed what had been a surprisingly good year. The snap-back rally that followed was impressive. Stocks closed the 2023 with nine straight weeks of advances, the longest such streak since 2004. Bonds recovered their losses, with the yields on two and ten-year Treasury bonds improbably ending the year just about where they had started.

Urgent predictions regarding the course of inflation and the economy might make for good reading, but like most headlines they are more likely to lead to investing whiplash than sound decisions. Staying on track requires alternating mantras, from “this too shall pass,” to “don’t get too excited.” Of course, it must be said that the economy and inflation might have developed in less favorable ways – the end-of-year rally was not preordained. Prudent investing acknowledges the possibility of a wide range of outcomes.

What remained fairly consistent through the year, at least after the regional banking scare, was a widening performance difference between the haves, large tech stocks perceived to be the primary beneficiaries of advances in Artificial Intelligence, and the have-nots, most of the rest of the market. The haves were led by the “Magnificent Seven“ - Apple, Amazon, Alphabet, Meta, Microsoft, NVIDIA, and Tesla. The have-nots included much of the S&P 500 - industrial, resource, real estate, and utility stocks, for example - as well as smaller and foreign stocks, many of them viewed as more cyclical, growth-oriented and/or reliant on debt than the Mag 7.

Before the year-end surge, the haves were running ahead of the rest of the market at a pace seen on only a few previous occasions, specifically the Covid bear market (2020) and the Great Financial Crisis (2008). The Mag 7 stocks ended 2023 with an average gain of 100%. The other 493 of the S&P 500 had an average return of 7%.

As we look forward, we’re reminded of a line from last year’s outlook: “Should [a soft landing] come to pass, Fed chief Jerome Powell would deserve a ticker tape parade down Broadway.” While there are always plenty of things that could go wrong, it appears that inflation is subsiding toward the Fed’s comfort zone without triggering a significant economic contraction.

The major risks in 2024 that bear watching are generally the same ones we saw in the year just ended. Geopolitical risks abound, including confrontations with China that could result in further trade upheaval or even, incredibly, inspire the use of force against Taiwan. History demonstrates that presidential election years are generally benign for US markets, at least until November, when we know who will win. US investors will once again be poring over economic data, looking for signs that the economy continues to chug along without a reacceleration of inflation or the long-awaited and oft-speculated pullback of the US consumer (we aren’t predicting either). Undoubtedly, the Fed has a close eye on both, as well as other key economic indicators, that will guide their decision making.

What does all this mean for returns in 2024? One-year forecasts can look out of date pretty fast – they are really for entertainment purposes only. We expect today’s favorable economic trends to evolve over the course of the year, and we will endeavor to not be fixated on a particular outcome. We expect a smoother ride for bonds. We believe that the best investing equity opportunities are currently to be found in companies outside of the “Mag 7”.