Domestic and International Market Trends
Domestic equities advanced in the fourth quarter of 2023, with the S&P 500 Index rising by 11.68% to cap off a strong year-end rally that saw the S&P 500 gain 26.56% in 2023. The main driver of the quarter’s positive performance was a shift from the Federal Reserve’s hawkish stance on monetary policy to a more accommodative stance after fourth-quarter inflation data showed continued progress in bringing prices back toward the Federal Reserve’s target goal. The Federal Reserve’s signaling of rate cuts in 2024 resulted in a sharp rally in Treasuries and a subsequent decline in interest rates. The 10-year U.S. Treasury yield peaked to near 5% in October and quickly retreated, ending the year below 4%. Equity markets rallied while the dollar weakened, leading to a risk-on environment to cap off 2023. Falling energy prices helped to further ease inflation due to weakening demand amid global growth concerns. Technology significantly outperformed over 2023 driven by an Artificial Intelligence (AI) frenzy, but the rally broadened out to end the year, bolstered by a rally in financial services and healthcare in the fourth quarter.
International equities participated in the global risk asset rally to finish 2023 but fared slightly worse than their domestic counterparts, as the MSCI EAFE Index posted a 10.47% gain in the fourth quarter. China was a drag on emerging markets as its economy continued to face weak demand, high youth unemployment, and a material decline in foreign direct investment. China’s economic problems have resulted in a tempered outlook for global growth. After strengthening earlier in the year, the U.S. dollar weakened against most major currencies, reflecting expectations of easier monetary policy.
Fixed-income markets rallied as bond prices rose, and yields fell in response to improved inflation data and a dovish-sounding Fed to close out 2023. Yields sharply declined in the quarter, and both investment-grade and high-yield credit rallied, resulting in tightening credit spreads. The Bloomberg U.S. Aggregate Bond Index rose by 6.82% in Q4, and corporate bonds outperformed government bonds. International and emerging market debt performed worse than domestic bonds, as higher U.S. interest rates and the strong dollar reduced the relative attractiveness of foreign bonds.
Economic Outlook and Central Bank Policies
Moving forward, investors will keenly observe economic indicators to gauge their influence on central bank policies and market dynamics. Risk markets finished the year strong, but after the December Federal Open Market Committee (FOMC) meeting, the market is now pricing in six 25-basis-point interest rate cuts in 2024, three more than the FOMC’s December dot plots signaled. Inflation is still at the forefront of investor concerns, but the material improvement during the second half of 2023 shifts investors’ focus to employment data. The health of the labor market will be pivotal in determining the Fed’s next steps as it weighs the balancing act between its dual mandate of stable prices and maximum employment.
Energy Prices, Inflation, and Economic Trends
While oil prices fell in the fourth quarter due to increased U.S. production and global growth concerns, geopolitical tensions in the Middle East remain a potential headwind in 2024 and could be a driving force for energy price volatility throughout the year. Core CPI, which excludes energy and food, continues trending down towards the Fed’s desired level, and the market waits for continued dovish policy. Meanwhile, in the broader economy, there are emerging signs that the Fed’s tightening measures are achieving their desired impact to slow activity down without a large uptick in unemployment. Excess savings have begun to dry up, and delinquencies on credit cards, which were previously at historical lows, have reverted to pre-pandemic levels. Higher mortgage rates have slowed an otherwise hot housing market, and looking ahead into 2024, mortgage rates should begin to decline. Slowdowns in venture capital fundraising and tech startups are further evidence that the Fed’s rate hikes are having the intended cooling effect on at least some areas of the economy. Overall CPI is expected to fall below 3% by the first quarter of 2024, moving the Fed closer to its 2% long-run target.
At the same time, consumer spending, a primary driver of the U.S. economy, has persisted despite some more selective behavior in specific areas. The beginning of holiday spending started strong, but retailers and other consumer discretionary companies signaled weak guidance, hinting at a more selective consumer to start 2024. The labor market remains strong, and wage gains grew to outpace inflation towards the end of the year, indicating that the consumer may enter 2024 with more buying power. This wage growth is now moderating at a rate to keep fears of a wage-price spiral at bay, leading to a potential best-case scenario for the economy more broadly. Notably, analysts are projecting corporate earnings growth of 11.5% and revenue growth of 5.5% in 2024. Quarterly GDP estimates remain positive over the next six quarters and have increased. These improvements support the idea that the elusive soft landing is becoming more likely.
China Concerns and Market Guidance
On the international front, China’s economic stability raises concerns, particularly about its property sector, domestic consumption, and high unemployment. The theme of a strong Chinese consumer, especially in the travel and leisure sector, finally regained its footing by the end of 2023, but the rate of spending was more subdued relative to pre-pandemic spending. Although the Chinese government has always been intent on stimulating the economy to keep up appearances during downturns, it may be increasingly more challenging to counterbalance foreign investor concerns and domestic economic problems.
Over the coming quarters, inflation and employment data will continue to guide the market. The ever-important holiday shopping season readout will provide important context on the health of the U.S. consumer looking forward to 2024. Here at Condor, we continue to believe in the soft-landing narrative that has become a consensus among Wall Street economists. However, we are not yet out of the good-news-is-bad-news cycle, where positive data may be received less positively than one might expect (because investors expect it will keep rates higher for longer), and weaker data may be viewed positively (since it may lead the Fed to ease sooner). While the short-term path forward can be unpredictable in this type of environment, as always, we urge investors to take a longer view. In the meantime, we will continue to lock in attractive yields in safer areas of the market while we can and would view any market pullbacks as opportunities to benefit in positions we believe in for the longer term.