THE SHORT STORY
The “Recession of 2023” that was widely forecasted failed to materialize. This does not mean we are out of the woods yet, but trying to time market cycles is a fool’s errand. Rather than “timing the market”, the focus should be on “time in the market”. Constructing a resilient portfolio designed to weather both ups and downs is one of the most effective ways to retain conviction through market cycles.
While there will always be material risks on the horizon that we uncover through our research, we are excited to be starting the year with a solid economic backdrop, inflation that is coming down, and a Fed that is set to take its foot off the brake. These factors combined with other technical considerations outlined below, and an environment more ripe for active management, set the stage nicely for what we believe will be a positive year for markets in 2024.
Where We’ve Been – 2024 Q1 Review
Following 2022, where the harsh Fed tightening cycle to combat inflation roiled markets, there were plenty of reasons to be concerned heading into 2023. Beyond ongoing interest rate hikes, market participants were anticipating that higher rates, persistent inflation, growing debt loads, petering out of stimulus, concerning geopolitical developments, and more would lead to broad economic and market weakness.
It came as a surprise, then, that markets were solidly higher in 2023. While this move higher was catalyzed by major developments in Artificial Intelligence (AI), falling inflation, and expectation of future rate cuts, it was also supported by what turned out to be a surprisingly robust economy.
How did such a strong economy come to be? Aside from consensus pessimism, there was a flurry of what turned out to be materially negative events such as geopolitical conflicts, ongoing rate hikes, banking failures, a downgrade of (and near default on) US government debt, commercial and residential real estate headwinds, and disappointing growth out of China.
While rising rates and many economic indicators supported forecasts for a faltering economy, hindsight makes it clear that COVID-era debt forbearance programs, excessive stimulus, and mass migration out of the workforce led to both a very tight labor market and a consumer flush with cash. In other words, consumer spending was surprisingly strong, causing many tried and true economic indicators to fail in their predictive value.
As is often the case in the investment world, however, things are not always as black and white as they first appear. Under the surface, alongside legitimate strength and returns, there have been some clear weak spots in both the economy and in markets.
Economically speaking, while we have thus far avoided a recession, there HAVE been many isolated parts of the economy that have gone through downcycles since COVID began. From hospitality and travel in the early parts of COVID, to tech and real estate during 2022’s aggressive rate hikes, to regional banks and commercial real estate in 2023 as the lagged effect of rate hikes took hold, the shock of COVID has left few areas untouched.
As it relates to markets, while they were strong last year, things were volatile. After a robust first seven months of 2023, August began a 3 month slide in both stocks and bonds, as long-term interest rates climbed to near 5% due to several factors. By the end of October, all signs pointed to a third year in a row of negative bond market returns – the first time in the market’s history this would have happened. Thankfully, moderating inflation and changing rhetoric out of the Fed drove rates lower, driving a rally in risk assets to finish the year on a very positive note. Bonds, specifically, experienced a top ten 2-month return of all time.
Overarching this rollercoaster of volatility in both stocks and bonds, most of the index strength throughout the year stemmed from only a small handful of companies riding the tailwinds of AI. These top companies, dubbed the “Magnificent 7”(Google, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla), comprised almost 30% of the S&P 500 index and finished the year contributing 60% of the S&P 500’s 26.3% return. Said differently, without these top 7companies, the S&P 500 would have returned closer to only 10% in 2023 (at some points during the year, the S&P 500 ex-Magnificent 7 was hovering around a 0% return).
Fourth quarter and 2023 returns are shown below.
|US Large Cap
|US Small Cap
|MSCI Emerging Markets
|BB US Aggregate
Where We’re Going – Q1 2024 Outlook
Looking forward to 2024, we find an array of reasons to be constructive on markets. Bond yields still sit at attractive levels, the Fed is taking its foot off the break, money market funds hold a record ~$6 trillion in cash that could begin flowing into bonds or equities, sentiment (a contrarian indicator) is still slightly bearish, and valuations outside of the “Magnificent 7” remain very reasonable compared to historical levels. And, although often a source of stress and consternation, the silver lining of election years is that they do tend to drive favorable outcomes in markets.
Beyond these items, we expect market volatility to be higher now that rates are no longer pegged near 0%. While seemingly counterintuitive, higher market volatility will offer increased opportunity for active portfolio management to generate superior investment returns in portfolios.
All this said, risks and uncertainties remain. After all, it could be said that investing is the art of taking risk with the expectation of achieving a commensurate return in the future. What risks are we wary of?
- The Federal Reserve will continue to be a driving force for markets. While rates are likely to be cut given falling inflation, inflation could bounce again – due to an isolated geopolitical event, trade wars, overheating labor market, or otherwise – and cause the Fed to resume its rate hikes.
- The dramatic outperformance in recent years of the “Magnificent 7”, combined with their lofty valuations and nothing-can-go-wrong consensus draws eerie parallels to the “Nifty Fifty” and “Dot-Com” bubbles of the past…both instances that saw strong performers at the time produce dismal returns in the years and decades ahead. Will it be different this time?
- Geopolitical uncertainty remains at heightened levels. In just the past several years alone, we have seen a war in Ukraine, a war in Israel, terror attacks and an ever-escalating trade war with China. Clearly, events can arise quickly and have a dramatic impact on the global economy.
- A tail-risk exists around the ever-deteriorating US debt situation. Ignoring unfunded liabilities stemming from entitlement spending, the US national debt stands at over $33 trillion. This could contribute to ongoing interest rate volatility.
Discover a Different Story
In an environment of economic uncertainty, we encourage focusing on all your gifts of wealth. When we redefine wealth to include your finances, but also your attitude, time, relationships, and abilities – your story transforms.
Here are a few prompts to help you root into a story of hope and contentment:
- What attitude can you adopt when going about your day?
- How and where will you spend your time?
- How will you invest in your treasured relationships?
- What impact could you have with your abilities?
Thank you for allowing us to partner with you as we navigate the ever-changing market. We appreciate your continued trust.
If you have questions or would like to dive deeper into this quarter’s outlook, please reach out to our investment team. We’d be happy to set up a virtual coffee to talk more.
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This material is provided for informational purposes only and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The views and strategies described may not be suitable for all investors. They also do not include all fees or expenses that may be incurred by investing in specific products. Past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. You cannot invest directly in an index. The opinions expressed are subject to change as subsequent conditions vary. Advisory services offered through Thrivent Advisor Network, LLC.
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Index Benchmarks presented within this report may not reflect factors relevant for your portfolio or your unique risks, goals or investment objectives. Past performance of an index is not an indication or guarantee of future results. It is not possible to invest directly in an index.
The Bloomberg U.S. Aggregate Bond® Index, or the Agg, is a broad base, market capitalization-weighted bond market index representing intermediate term investment grade bonds traded in the United States. Investors frequently use the index as a stand-in for measuring the performance of the U.S. bond market.
The MSCI EAFE® Index is a broad market index of stocks located within countries in Europe, Australasia, and the Middle East.
The MSCI Emerging Markets® Index is a selection of stocks that is designed to track the financial performance of key companies in fast-growing nations.
The Russell 2000® Index measures the performance of the 2,000 smaller companies that are included in the Russell 3000® Index, which itself is made up of nearly all U.S. stocks. The Russell 2000® is widely regarded as a bellwether of the U.S. economy because of its focus on smaller companies that focus on the U.S. market.
The S&P 500® Index, or the Standard & Poor’s 500® Index, is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies.
The U.S. Dollar Index – known as USDX, DXY, DX and USD Index – is a measure of the value of the United States Dollar (USD) against a weighted basket of currencies used by U.S. trade partners. The index will rise if the Dollar strengthens against these currencies and fall if it weakens.