2023 4th Quarter Market Commentary
Top Headline for Q4: The End of Rising Rates!
After a rough 3rd quarter, stocks saw continued weakness to start the 4th quarter. The equal weighted S&P 500 Index (RSP) saw a drawdown from late July through late October of -13.4%, before equity markets bottomed and began an impressive rally to end the year. Perhaps what was more impressive was the broadening out of market participation after the first nine months were dominated by mega-cap technology. Markets surged in Q4 as participants correctly anticipated a “dovish” tilt to actions by the Federal Reserve Bank (the “Fed”). In December, Chairman Jerome Powell effectively affirmed what markets anticipated (that is, they’re likely done raising rates).
The move in the bond market was even more striking as bond prices turned up sharply in October and rose through year-end as rates fell. In fact, the 10-Year U.S. Treasury Bond yield briefly eclipsed 5% in October before plummeting to under 4% at year-end on rising bond prices – a remarkable move over such a short period of time. The Treasury market did not offer much time to capture a 5% long-term yield.
In summary, 2023 was a testament to the resilience of the U.S. equity market as investors overcame a great deal of fear and uncertainty. The narrative shifted in 2023 from how much more the Fed would hike rates, to when the Fed would stop hiking rates, to how much rates would potentially drop in 2024. The market faced headwinds including high inflation, the ongoing Russian-Ukraine war, a regional banking crisis, conflict in the Middle East and the seemingly never-ending prediction of the country entering a recession. Entering 2023, investors were coming off a year where the Fed was still waging its fight against inflation and had hiked the Federal Funds Rate from 0% to 4.25% to end 2022. Over the first seven months of 2023, the Fed would continue to raise the Federal Funds Rate four more times, to a target of 5.25 – 5.5%. Despite the continued rate hikes, as a forward-looking indicator, the stock market paid more attention to falling future inflation expectations. The annual inflation rate was around 6% at the start of 2023 and ended the year near 3% - welcome news as we head into 2024.
General Market Update
US Equities: During Q4, the equal weight S&P 500 Index (RSP) rose 11.8%, the Nasdaq Composite was up 13.6% and the small company Russell 2000 Index also rose 13.6%. It was a strong quarter for most sectors. A few standouts include the interest rate sensitive REIT sector (e.g., XLRE was up a whopping 18.8%) and long duration equities, like technology, fared well (e.g., XLK was up 17.7%). The 4th quarter’s performance capped off a strong year for equities as the broad indices all finished well above historical averages.
As we’ve mentioned before, much of market performance during 2023 was driven by the “Magnificent 7” stocks (Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA, Tesla), which now make up about 30% of the cap-weighted S&P 500 Index. This is one of the highest levels of market concentration in history and one of the reasons why we don’t reference it as a relevant performance benchmark for a diversified portfolio. During the second half of 2023, Patina Wealth began to overweight sectors selling at more favorable prices and indices with an “equal weight” methodology. This strategy started to pay off in Q4 as the equal weighted S&P 500 (ticker: RSP) ended Q4 +11.8%. Moreover, sectors such as financials and industrials, and asset classes such as small caps, that lagged the overall market for much of the year, began to “catch up” as market performance and participation began to broaden out. The financial sector (XLF) surged +13.9% during the quarter, the industrial sector (XLI) was +13.1% and small caps were +13.6%.
International and Emerging Market Equities: International equity markets also performed well during the quarter. The Schwab International Equity ETF (SCHF), which holds stocks of developed markets excluding the United States, was up 11.0%, and the Schwab Emerging Markets ETF (SCHE) was up 7.1%. Although international markets joined the rally in Q4, some significant headwinds remain. Specifically, many European countries continue to wrestle with low economic growth and high inflation. Also, China is facing substantial challenges both from a hangover of real estate overbuilding as well as investor fears surrounding government intervention in the technology sector.
Fixed Income and Credit: As mentioned above, Q4 was a huge quarter for fixed income investments with long maturities (i.e., high “duration”). By way of example, VCLT (an ETF that holds a basket of long-duration corporate bonds) was up 13.9% on the quarter. It’s striking how quickly the bond market sentiment shifted. In three short months, uncertainty around the future of inflation dissipated, and the long-term bond market yields shifted quickly to reflect a much lower future expectation for inflation.
Pro-Inflation Investments: Inflation continues to fall toward the Fed target of 2% with positive data coming in Q4. However, with the rate still hovering around 3%, the work is not over, and many economists suggest that 3% is more likely for the next decade than 2%. One factor working against the Federal Reserve Bank’s efforts is U.S. Government fiscal spending. The 2023 budget deficit is projected to be above $2 trillion with a similar number projected for 2024. Similar deficit spending is occurring throughout the developed world. Our belief is that more austerity will be required to return to a 2% inflation world and that inflation-protection may benefit portfolios.
A Look Ahead
With the abrupt move in the long-bond market in Q4, there is some diminished opportunity for additional bond price appreciation going forward. With the 10-Year Treasury rate below 4%, many economists would say that it is “fairly priced,” meaning that it is reflective of long-term growth/inflation. It is tough to be too bullish on longer-term bonds here given the 4th quarter move and the present level of the 10-Year yield. More conservatively invested portfolios will continue to be diversified across duration.
On the equity front, it will be important to stay nimble. While it would not be a surprise to see some sort of consolidation early in 2024 after such a surge to end 2023, we believe the breadth of participation in the latest rally from sectors that underperformed growth and technology for most of last year is a positive sign. There is still a large amount of cash sitting in money market funds that could find its way into the stock market and thus provide a tailwind for equities.
The Federal Reserve Bank actions will continue to loom large. Not only has the market assumed that the rate hiking campaign is over, but the futures market shows that the market has also “priced in” substantial rate cuts for 2024. While this is all bullish news for the equity market, it is important to note that any material shift toward tighter conditions could create some downside volatility.
2024 is shaping up as another active year in the markets as cash-heavy investors look to deploy funds based on insight from Fed actions, inflation readings, and developments on the geo-political front. Volatility provides opportunity for active managers like Patina Wealth. We will continue to seek opportunities for strategic rebalancing in an effort to improve return and reduce risk. Best wishes for a prosperous 2024!
Sam Harris - Crozet/Charlottesville John Mumper - Richmond
(434) 214-0407 (804) 380-1050
Sam@PatinaWealth.com John@PatinaWealth.com