We hope this newsletter finds you well, having enjoyed the holidays and looking forward to a happy, healthy and productive 2024. As we, at Atlas, are reinvigorated with the new year, we would like to take some time to reflect on the past year in the economy and markets and offer a look forward toward what may lie ahead.
To the surprise of most stock and bond market participants, the economy in the U.S. outperformed expectations for 2023 in three major areas: economic output, labor market resilience, and slowing inflation.
In late 2022 and into 2023, the consensus outlook for the year involved the probability of an economic recession accompanied by rising unemployment. In fact, the economy grew quite nicely in the first three quarters of the year. The first and second calendar quarters saw year-over-year increases of above 2%, and the third quarter came in with 5.2% growth. Meanwhile, the unemployment rate remained low, starting the year at 3.4% in January and only moving to 3.7% in December. 1
As for inflation, the hawks have prevailed as inflation has been brought down more than many anticipated. As you may recall, inflation peaked in June of 2022 at an annual rate of approximately 9.1%, and held at 6.5% in December 2022. 2 The most recent report as of this writing shows the annual rate having dropped to 3.1% (December 2023), with the month-over-month number showing a 0.1% increase.1 While we view these reports with some critical interpretation (energy prices have seen decreases in the fall of 2023), the notion that inflation may become less of a concern for consumers could serve as a tailwind to continued economic growth.
Most experienced investors acknowledge that the single most important factor driving stock prices over the long term is earnings, or company profitability. At its most basic, stock research can be thought of as the hunt for investable companies with the most reliable projections for future profitability. For some time, companies have had a rather difficult time growing earnings/profitability, but since mid-2023 appear to be emerging from that slump.
While the earnings reporting season for Q3 2023 has yet to conclude as of this writing, the blended (year-over-year) earnings growth rate for the S&P 500 is estimated to be 4.3%. This would be the first quarter of year-over-year earnings growth since 2022. Looking ahead, the consensus analyst’s estimate for 2024 indicates double digit potential of 11.6%.3
Despite a negative period in the stock market from August through October, all of this has resulted in stock market returns that have noticeably outperformed the expectations of many coming into the year.
As for bonds, the biggest surprise was that with the economy not tipping into recession during the year (despite the negative yield curve predictions of 2022). Had the economy fallen into negative growth/recession, it would have been natural to see the historic rise in interest rates stall, helping to mitigate some of the damage done in the bond market.
However, rates continued to march higher as the economy continued to grow, and the Fed took historic actions in their handling of the Federal Funds Rate to curb inflation. As a result, by late 2023 the overnight lending rate reached its highest level in 22 years.4
In November market participants began to suspect that the rate hike cycle was at or nearing its end, and bond buyers came out. While short term rates remained elevated, intermediate term rates fell. In the late fall, the yield on the benchmark 10-year U.S. Treasury Note fell from just under 5.0% down to 4.0% in early January5. In addition, spreads (the additional yield investors expect in exchange for taking on default risk) shrunk. Does this signal the recovery of the bond market from two years of historic declines? Only time will tell, but now that yield has returned to the bond market, we look on it as a relatively attractive asset class once again.
Looking ahead to 2024, we are encouraged by the fact that contrary to the opinions of many, the Fed seems (so far) to have done a worthy job of combatting inflation without sending the economy into a harmful recession. The “long and variable lags” that are so often cited in Fed speak, have hardly shown up. As of now the economy seems to be accelerating, the consumer is hanging in and people still have jobs. Has the Fed engineered a “soft landing” or “no landing” for the economy? We can hope.
As for our outlook, we are wary of any indications that the economy may slip into recession in 2024. Chiefly, we are concerned with the consumer, and their ability to continue to grow their spending. Some indicators show a limited ability, but we recognize that this has been the case for many months. The other possibility is that the economy remains strong and provides the catalyst for consumers and businesses to maintain viable financials for the future.
We remain constructive that we’ll continue to see moderate economic growth in 2023, perhaps aided by cuts to Fed controlled rates starting in the spring. We’re cognizant that this is an election year, and: 1) equity market returns tend to be muted in election years, 2) markets are subject to political headline risks, and 3) historically, the Fed has been reluctant to make significant policy moves in the weeks before a presidential election.
We expect that the economy will avoid recession, equity markets will continue to show volatility as the elections near (particularly in the energy and health care sectors). But with current expectations for growth in corporate profits, both stocks and bonds are anticipated to provide attractive returns for the year.
As of the time of this writing, bond market participants seem to anticipate that the next Fed action could take place in the form of a rate cut at the March meeting (2024). While this is not a certainty, the odds at this time seem to slightly favor a possible first cut then. Subsequent Fed meetings in May, June and July currently carry higher odds for a cut. However, as mentioned above, we think that the Fed will be wary of making changes too close to the November election, and accordingly may choose to move early in the year.
That said, (as always, but particularly in an election year) a prudent investor should be sure to have all the components of a diversified portfolio in place, and then stick to a longer-term strategy that is designed for more than one election cycle.
As always, we at Atlas remain focused on these issues, and are watchful for any opportunities that may result. If you have any questions about this or any other financial matter, please feel free to contact your Atlas Wealth Management Advisor. We are readily available to serve you.
Footnotes and Sources
[1] U.S. Bureau of Labor Statistics https://data.bls.gov/timeseries/LNS14000000
[2] Inflation Breakdown https://www.cnbc.com/2023/01/12/heres-the-inflation-breakdown-for-december-2022-in-one-chart.html#:~:text=Here%27s%20the%20inflation%20breakdown%20for%20December%202022%20%E2%80%94%20in%20one%20chart,-Published%20Thu%2C%20Jan&text=The%20inflation%20rate%20fell%20again,9.1%25%20peak%20in%20June%202022
[3] FactSet Earnings Insight January 5, 2024 https://advantage.factset.com/hubfs/Website/Resources%20Section/Research%20Desk/Earnings%20Insight/EarningsInsight_120823A.pdf
[4] Federal Reserve Bank of New York – Effective Funds Rate https://www.newyorkfed.org/markets/reference-rates/effr
[5] 10-year U.S. Treasury Note https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/real-estate-stocks-rally-as-us-bond-yields-tumble-79703088
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