Key Updates on the Economy & Markets
Financial markets underwent a sizeable shift in the fourth quarter. Treasury yields, which spiked in Q3, reversed lower as inflation eased and the Federal Reserve hinted at interest rate cuts in 2024. The decline in interest rates was a significant tailwind for stocks and bonds. The S&P 500 gained +11.6% during the quarter, and bonds produced their best quarterly return since Q2 1989. This letter recaps the fourth quarter, discusses the decline in Treasury yields and the potential for interest rate cuts, and looks ahead to 2024.
Treasury Yields Reverse Lower in Fourth Quarter
Following a significant increase in Q3, Treasury yields moved sharply lower in Q4. Figure 1, which compares the change in yields during the two quarters, graphs the opposing interest rate moves. The gray bars show yields increased in Q3, with longer maturity yields rising the most. In contrast, the navy bars show yields reversed sharply in Q4, erasing nearly all their Q3 rise. The abrupt reversal can be attributed to a significant change in the market’s view heading into 2024.
With Inflation Falling, Market Expects Rate Cuts
Data shows that inflation pressures continue to ease. Headline inflation, which peaked at 9.1% in June 2022, dropped to 3.1% in November 2023. Likewise, core inflation, which excludes the volatile categories of food and energy, now stands at 4.0% after peaking at 6.6% in September 2022.
U.S. Economy Defied Expectations in 2023
The question heading into 2023 was whether the economy could withstand the effects of higher interest rates. The Federal Reserve aimed to cool inflation by raising interest rates and reducing demand, and the central bank appeared to be well on its way toward accomplishing its goal. The cost of capital was rapidly increasing. The housing market and home construction activity were slowing. Shipping rates were falling as freight demand declined and supply chains normalized. While portions of the economy slowed in 2023, the broader economy displayed remarkable resilience, even as the Federal Reserve continued to raise interest rates.
U.S. Economy Defied Expectations in 2023
The question heading into 2023 was whether the economy could withstand the effects of higher interest rates. The Federal Reserve aimed to cool inflation by raising interest rates and reducing demand, and the central bank appeared to be well on its way toward accomplishing its goal. The cost of capital was rapidly increasing. The housing market and home construction activity were slowing. Shipping rates were falling as freight demand declined and supply chains normalized. While portions of the economy slowed in 2023, the broader economy displayed remarkable resilience, even as the Federal Reserve continued to raise interest rates.
Multiple Stock Market Indices Recover to January 2022 Levels
Falling interest rates were a tailwind for stocks in the fourth quarter. Key stock market indices like the S&P 500, the Dow Jones, the NASDAQ 100, and the Russell 2000 each returned more than +11%. The broad-based stock market rally demonstrates investors’ growing enthusiasm, with inflation falling, the economy surpassing expectations, and the Fed signaling the end of rate hikes.
What does the financial landscape look like today? Following the Q4 rally, multiple major stock market indices are trading near its January 2022 highs.
Credit Market Recap – Bonds Rally as Yields Fall
Bonds traded higher in Q4 as Treasury yields reversed their Q3 rise. The Bloomberg U.S. Bond Aggregate, which tracks a broad index of U.S. investment-grade rated bonds, produced a total return of +6.7%. It marked the first quarterly gain since Q1 2023 and the biggest quarterly gain since Q2 1989. This shift in investor sentiment toward bonds can be attributed to several factors, including two themes we’ve already discussed. Inflation is falling, and the Federal Reserve is expected to start cutting interest rates.
2024 Outlook – What to Watch?
The markets enthusiasm in the 4th quarter of 2023 was built on expectations of multiple interest rate cuts and continued economic growth, without worry of a spike in inflation.
However, as we head into 2024, there are many variables that could add volatility and sway the eventual outcome to market performance. It is far from certain whether current expectations will materialize exactly as anticipated. In addition, we still have multiple geopolitical concerns surrounding Russia/Ukraine, the Israel/Hamas conflict, escalating tensions between the U.S. and Iranian backed militias throughout the Middle East as well as China’s unwelcomed ambitions to reunify with Taiwan. On the home front, we have yet to see a long-term compromise on funding the government, so the possibility of a shutdown still remains.
Current market valuations suggest we will see above average earnings growth for S&P 500 companies. The consensus earnings expectations for 2024 are mostly between $245-$250. That’s nearly 10% higher than the expected earnings for 2023. History has taught us that when the markets become complacent and investors are all reading from the same playbook, it is best to be cautious. “There is no better teacher than history in determining the future.” ~Charles T. Munger.
As always, in 2024 we will be looking for opportunities in the market where valuations are favorable. We believe that by carefully analyzing market trends and conducting thorough research, we can identify undervalued assets. This strategic approach will allow us to make informed decisions and over the course of the upcoming year.
This material prepared by TrinityPoint Wealth is for informational purposes only. Additional data provided by MarketDesk Research. It is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy, or investment product. Opinions expressed by TrinityPoint Wealth are based on economic or market conditions at the time this material was written. Economies and markets fluctuate. Actual economic or market events may turn out differently than anticipated. Facts presented have been obtained from sources believed to be reliable. TrinityPoint Wealth, however, cannot guarantee the accuracy or completeness of such information, and certain information may have been condensed or summarized from its original source.