ECONOMIC AND MARKET REVIEW AND OUTLOOK, JANUARY 2024

Economics is a branch of astrology that thinks it’s a branch of astronomy.” — Anonymous

Year End Summary

The fourth quarter of 2023 featured an exclamation point to the year, with an October swoon in both equity and fixed income markets leading to an “everything rally” in November and December.

For the year, the S&P 500 returned over 26%, although the breadth of the market was sorely lacking, with the mega cap stocks such as Apple, Microsoft and Amazon up strongly, while about 72% (about 360 stocks) of the index underperformed the total. Foreign equities also did well, led mainly by developed nations.

After a dismal 2022, bonds also went up, although the yield on the 10-year Treasury did a roundtrip, starting out the year at 3.88% then spiking to 5% in early autumn before falling back to 3.87% to close out 2023. Commodities were mixed, with WTI (West Texas Intermediate) oil falling almost 12%. Gold rose about 13% despite rising short term Fed Funds rates. This was largely due to steady buying by central banks, especially China.

The Dog That Didn’t Bark

A major positive surprise this past year was the persistent strength in the U.S. economy, with households spending and companies hiring more people.

Since the onset of Covid, economic forecasting (which many say is only a pseudo-science) has become even more difficult. For example, excess consumer savings from pandemic stimulus checks were estimated at about $800 billion at the beginning of 2023. In October, however, the government announced that consumers actually had $1 trillion more in savings than before the pandemic. This cushion kept personal spending from weakening significantly, even though sentiment surveys reported grouchy households complaining that prices were not falling back to 2019 levels. Further, many small businesses — a prime source of new job hiring — are cautious about the economy yet are very reluctant to lay off workers due to the recent shortage of workers in 2021. Job growth, therefore, has also proven to be a pleasant surprise.

Geopolitical Problems Fester Under the Surface

The October Hamas attacks in Gaza have added a new layer of uncertainty to global unrest. The war in Ukraine is still showing no signs of resolution. Shipping has been disrupted in the Red Sea, with many freight companies forced to go around the Cape of Good Hope in South Africa to deliver goods including oil, a time consuming and costly process. Ironically, North American based oil and gas explorers are benefitting, with many European countries importing energy from safer and shorter North Atlantic routes.

Although the current global situation is worse than it was pre-pandemic, the crisis should be manageable absent a direct war erupting between Iran and Israel. Since the end of World War II, Middle East conflicts have flared up every several years, with each outbreak eventually petering out. The situation does require close monitoring, however, especially if shipping is cut off at the critical Straits of Hormuz.

Interest Rate Expectations and the Election

Both the stock and bond market rallies late last year were due to a recalibration of Fed Funds rate expectations. Currently, futures markets expect the Fed to begin cutting interest rates in March, with a total of six cuts totaling 150 basis points (or 1.50%) for the entire year. However, Federal Reserve projections show only three cuts for a total of 75 bps (basis points) for 2024.

With such a divergence in the forecasts, clearly one side will be wrong in its assessment. If it is the markets, it’s likely that stock and bond prices may give back some of the fall 2023 rally. Therefore, economic reports between now and the March FOMC (Federal Open Market Committee) meeting will be crucial in divining which prediction is correct. A “good news is bad news” scenario, in which good economic news is bad news for financial markets (by implying that the Fed will not cut early and often), could occur and cause some choppiness in the financial markets in the first half of the year.

2024 is also a presidential election year, and markets will be subject to headline risk for most of the year. We caution not to draw any conclusions from current opinion polls, which like economic forecasts, tend to be less accurate as time goes on. Things may become clearer towards late October, with markets discounting the industries and stocks that will be the winners or losers by mid-November.

Current Portfolio Positioning

With all of today’s uncertainty, we believe that a diversified portfolio based on strong fundamentals and balance sheets remains the best way to navigate through this period. The fixed income approach should also be flexible, with the option of adding to bond maturities if longer-term yields begin creeping higher again. A longer-term horizon paid off handsomely for investors last year and we feel it will continue to do so again in 2024, even though returns may not be quite as robust as they were in 2023.