Happy New Year to you and your loved ones from all of us at Socha Financial Group. Last year turned out to be a better year for the markets and the economy than nearly everyone expected. Most market forecasters predicted the S&P 500 would end the year where it started, at best, while some had forecasts as low as 3,300, rather than 4,770 where it finished the year. Most economists predicted the US economy would slip into a recession in 2023, but instead, the US GDP grew at above trend growth of about 2.9% (Q4 GDP has not been released yet). Most equity strategists suggested investors should focus on value stocks over growth stocks in 2023, yet the S&P 500 Value ETF was up 21% while the NASDAQ 100 (growth) was up 55% and the S&P 500 was up 26%. The pattern here is clear, no one expected the kind of year 2023 turned out to be. One prominent economist shared that since COVID it has been the most difficult environment in his career to forecast, and 2024 looks to be no different.
At the December Federal Open Market Committee (FOMC) meeting, the Federal Reserve (FED) pivoted and acknowledged that interest rates are likely at their peak for this tightening cycle, but they will remain data dependent. The dot plot, which is an average of where the seven members see interest rates going in the future, suggests they will cut interest rates three times in the coming year. The market however, was more aggressive and priced in six rate cuts in 2024 with a 70% probability of the first one happening at the March meeting and a 100% chance of a rate cut by June. A strong December nonfarm payroll report caused the market to decrease these probabilities temporarily but nevertheless some rate cuts in 2024 are likely. Just as rate hikes hurt the markets in 2022, rate cuts tend to be supportive of markets.
The US economy is expected to have grown 2.9% last year assuming fourth quarter GDP comes in at 2.5%, which is what the Atlanta Fed GDPNow is predicting. It is likely the economy will slow in 2024 but the probability of a recession has decreased. Consumer spending makes up two thirds of the American economy, and last year consumers hung in there and kept spending. Credit usage did increase but consumers also benefited from strong wage gains and strong real wage gains as inflation came down. Going into 2024, the economy can still grow. Consumer spending should continue to increase albeit at a slower pace. There are not huge excesses in the cyclical parts of the economy. Credit usage is increasing but delinquencies are not a problem by historical standards. That leaves government and business investment spending, neither of which we think are going to collapse. Taking all of that into account, we think the economy will return to trend growth of +/- 2%, barring any unforeseen shocks.
Inflation has been steadily declining from the June 2022 high of 9.1% to 3.1% in November. Shelter costs remain the largest component of inflation and the slowest to decline. Rents have stopped rising and have begun to fall but by the nature in which the shelter component is measured it has a long lag. Transportation services currently makes up the largest part of core services ex-shelter CPI inflation. The largest component of this is auto insurance. We expect this to improve as the auto market normalizes. With these two large contributors to CPI coming down, we think it is conceivable that we hit the FEDs 2% inflation target by the end of the year. Increased oil prices due to the tensions in the middle east could have an upward effect on inflation temporarily, but the overall trend remains downward.
The December Nonfarm payrolls report came in better than expected with the US economy adding 216,000 jobs and the unemployment rate at 3.7%. This was the 25th straight month with unemployment below 4% which is the longest stretch since 1969. While the labor market remains tight, it is beginning to normalize. Job openings peaked at 12 million in March of 2022 and have fallen to 8.79 million in November. If this trend continues, job openings should be back to pre-pandemic levels by the summer. A normalizing of the labor market should result in wage growth slowly coming down, which will put downward pressure on inflation.
This year is an election year and while election years have historically been positive years for the equity market, it is important not to let your feelings about politics affect how you invest. For example, if you were not a fan of President Obama and got out of the market, you would have missed out on a 16.3% annualized return on the S&P 500. Alternatively, if you did not care for President Trump and sold equities you would have missed out on a 16% annualized return over his term. The economy has historically done better when Democrats are in control while the equity market has done better under Republican control. A divided government has historically resulted in the worst performance for both the economy and the equity market.
While nearly all forecasters suggested investors should have a value tilt, or worse, be out of equities all together, it was the large cap growth companies that led the market higher in 2023. In our portfolios we maintained our growth exposure, which we benefited from last year. In 2022 we went up in quality in our growth positions but maintained the exposure, nonetheless. It is hard to time the direction of the market or when a certain style of investing may outperform, particularly in this post-COVID world. Therefore, when we build the portfolio, we focus on diversification and strive to find the best investments that fit that asset allocation. On the bond side, we couldn’t predict the magnitude of which interest rates were going to rise, but with interest rates at zero we were confident that there was a greater risk that rates would rise than fall. Thus, we kept the interest rate risk (duration) in the portfolio low and were able to avoid a lot of the 18.34% draw down seen in the Aggregate Bond Index.
In conclusion, the economy grew significantly more than most people expected in 2023. The FED pivoted in December and is now signaling there will be rate cuts in the future rather than hikes. These factors along with a relatively healthy consumer, a strong but normalizing labor market, and a lack of excesses in the cyclical parts of the economy decrease the risk of a recession in the year ahead. That being said, the long and variable effects of the tightest monetary policy in four decades may yet to be seen. Should we see a recession, we think there is a higher probability that it is short and shallow rather than long and deep. Both stocks and bonds performed well in 2023. The S&P 500 gained 26%, the NASDAQ 100 gained 55%, and the US Aggregate Bond Index returned 5.5%.
We wish you well in the year ahead! Certainly, reach out to me (Michael) or your advisor with any specific questions you may have. Happy New Year!
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