The last quarter of 2023 was marked by a sudden turning point in the interest rate rhetoric of the Fed, a resilient economy led by a strong consumer, and a normalization of inflation. At the end of Q3, the Fed continued to raise interest rates as investors continued to wonder when the hikes would come to a halt. Consequently, bond and equity markets shed nearly all the gains earned for the year; however, at the beginning of Q4, and against the backdrop of bullish economic growth, the Fed pontificated their plan to stop raising rates for the time being.
S&P, Dow, and Nasdaq
After a historically dismal year in 2022, stocks accelerated in 2023, with the S&P 500 and Nasdaq jumping more than 20% and 50%, respectively. The Dow Jones Industrial Average is also up about 11% for the year. This was largely attributed to the Fed taking their foot off the gas with interest rate hikes, which instilled confidence in investors to jump back into stocks with hopes of a soft landing. Specifically, high-growth, cyclical technology, telecom and consumer discretionary sectors have outperformed other S&P 500 sectors for the year. Defensive sectors, including the utilities, healthcare, and consumer staples, have been the biggest laggards in 2023.
A Waltz of Interest Rates
To recap the tumultuous swing in interest rate policy, we start at the rapid and authoritative rate hikes that began as soon as COVID period ended. Next, we entered a multi-month “no change in rates” period where the Fed was gauging the impact of the hikes across the broader economy. During this period, regional bank failures, fears of a US recession, and geopolitical tensions mounted on top of the already problematic rising inflation. As a result, rates continued to creep upward into the first half of 2023 until a pause was finally announced by the Fed. Now, the beginning of a sequence of rate cuts is anticipated, and questions of how low they will go, when, and at what pace still loom in the market.
The Tennis Ball and the Egg
Gains were largely attributed to only a handful of mega-cap technology companies. In fact, the 10 largest stocks in the S&P 500 index, which are concentrated in technology and communications, experienced appreciated valuation multiples in the absence of robust earnings growth. This ultimately added rocket fuel and almost propelled the S&P back to its high for the year. However, the divergence between the winners and losers is staggering; companies like Pfizer and Johnson & Johnson have shed more than $30 billion each in market value, while Apple and Microsoft have surprised to the upside of almost $1 trillion in market value gains for the year.
Outlook for 2024
While we have seen bullish trends begin just in time for the new year, interest rate shock from the past 18 months is expected to hinder economic activity in the year ahead. The expectation for slower earnings growth, softening consumer demand, and rising geopolitical risks present hurdles for a sustained positive change on inflation and growth, potentially leading us into a mild or worse recession. At the same time, valuations of risky assets are considered expensive, but should interest rates stabilize or even decline, higher-yielding assets such as dividend-paying stocks may continue to rise accordingly. 2024 also reminds us to look ahead at emerging themes in generative AI products and their fit within the economy. ChatGPT and other AI services experienced technological breakthroughs this year, and investors subsequently demanded higher exposure in their portfolios. It seems inevitable that AI will play an increasingly important role in the future economy, and investors appear to recognize the market is only starting to move the chess pieces towards a long-term AI boom.
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