Happy New Year!
From everyone here at IMG, we hope you enjoyed your holiday season and that 2024 is off to a great start. It’s hard to believe that it has been four years since the first U.S. laboratory confirmed case of COVID-19. While the federal Public Health Emergency ended in May 2023, the pandemic reshaped America. The impacts are numerous, spanning healthcare, education, communication, employment, business and the economy. The shift to living with COVID versus in fear of it had ramifications as surging consumer demand was met with labor and supply shortages. This caused inflation to heat up and the Federal Reserve (Fed) to repeatedly intervene with rate hikes. As we enter 2024, we are optimistic that inflation is contained and the Fed can reverse course and reduce interest rates. If the pandemic taught us anything, it is resilience!
2023 At a Glance
- U.S Federal Reserve Policy
Inflation loomed as the top economic threat in 2023. After leaving interest rates at near-zero percent for two years to give the economy time to recover from the pandemic, the Federal Reserve raised its benchmark interest rate by a quarter point in March 2022 for the first time since 2018. The Fed’s monetary tightening campaign continued throughout 2023, culminating in a final 25 basis point increase in July. This brought its benchmark interest rate to a range of 5.25% to 5.50%, a 22 year high. Inflation has since tapered back toward the Fed’s 2% target, enough that the majority of Fed officials also expect 75 basis points worth of rate cuts in 2024 and 100 bps worth of additional cuts in 2025, according to the latest economic projections released at the conclusion of the December Fed meeting.
- Rising Rates Play Out
As the implications of aggressive monetary tightening filtered through the economy, those areas highly associated with interest rates were impacted more acutely.
In March, a series of bank collapses: first Silvergate Bank, then Silicon Valley Bank, and finally Signature Bank, underscored the downside of rising rates and interest rate risk. The Fed, FDIC, and the U.S. Treasury together acted swiftly to secure all depositors of failing banks. The Federal Reserve Board also announced the creation of the Bank Term Funding Program (BTFP) to help ensure banks could meet the needs of all of their depositors in the future. These actions reassured markets that the banking system was healthy and strong and dodged broader negative economic implications.
The Fed’s tightening campaign also squeezed the housing market, as higher mortgage rates, elevated home prices, and historically low housing inventory made home ownership out of reach for many. With many homeowners who locked in low mortgage rates in recent years unwilling to move (and forfeit those loans to take on a different mortgage at a significantly higher cost), the supply of houses plummeted. In turn, this drove up prices, making it especially difficult for first time buyers to afford a home. 2023 home sales are on track to be the lowest since at least 2011. After reaching an all-time record low of 2.65% in January 2021, the average 30-year fixed rate surged to 7.79% in October 2023, and has since receded below 7% in mid-December for the first time in four months.
- The Debt Ceiling & Government Spending
When the Treasury Department reached its debt ceiling of $31.4 trillion in January, there was dissension in Congress around lifting the borrowing cap. The Treasury implemented “extraordinary measures” to keep spending within the limit, but that would only last so long and it was expected to breach the current debt ceiling on June 1st. An actual default could create a panic, since any perceived threat that Treasury investments are no longer safe could have profound financial and liquidity implications. A default could affect global financial markets, especially since other countries rely on the economic and political stability of U.S. debt instruments. Fortunately, Congress was able to pass a debt limit bill at the final hour to avoid default, suspending the nation’s debt limit through January 1, 2025. This effectively pushes the issue beyond the 2024 elections, in exchange for spending cuts and reforms. An end to the debt-ceiling crisis provided some much needed relief and stability to markets.
Separately, a federal government shutdown was averted in September and November 2023, and the next deadline is January 19th. Government spending is generally authorized one fiscal year at time; a government shutdown occurs when leaders cannot reach an agreement on government spending by the deadline. While this is completely separate from the debt ceiling and does not impact U.S. debt instruments, the risk of a government shutdown underscores the disagreements around spending. Spending by the U.S. government is the highest it has ever been outside of wartime, and deficits are already very high.
- The Consumer Juggernaut
The U.S. economy defied predictions that it would tip into recession in 2023, largely because inflation waned while consumers kept up their spending. Robust consumer spending and historically low unemployment have supported solid U.S. economic activity. The labor market continued adding jobs in 2023, although at a slower pace than in 2022. Recently, wage gains have eased, but inflation has cooled faster, leaving many workers better off.
U.S Economy
The Fed has made a lot of progress and inflation continues to trend downward toward their 2% target. Prices in November rose 3.1% from a year ago, a significant retreat from the peak rate of 9.1% for the year ending June 2022, according to the Bureau of Labor Statistics consumer price index (CPI). Core inflation, which excludes food and energy, was up 4% in November from a year ago. Worth noting is that the shelter index, which reflects housing prices and rent, increased 6.5% over the last year, accounting for nearly 70% of the total increase in the core CPI, as higher interest rates disrupted the housing market.
Gross domestic product (GDP), the broadest measure of economic output, rose at an annualized rate of 4.9% in the third quarter. GDP is adjusted for inflation and seasonal swings. According to the private consensus for real economic growth as measured by the Blue Chip Economic Forecast, GDP is projected to expand 2.6% in 2023. A year ago, the consensus was for negative 0.1% growth in 2023.
Unemployment came in at 3.7% in November, down from 3.9% in October. This is little changed from a year ago and modestly above a 50-year low.
For now, it seems that the Fed may have achieved a “soft landing,” i.e., taming inflation without triggering a recession. Historically, a big drop in inflation requires a dramatically cooling economy as weaker consumer and business demand leads companies to lower prices and reduce their workforce (or employees accept smaller pay raises). However, the post-pandemic recovery has been different. After declining 3.4% in 2020, GDP shot up 5.7% in 2021 as it emerged from the COVID-19 recession. The boom came with supply chain disruptions, as well as product and worker shortages that sent prices soaring. As supply driven troubles resolved and after 11 rate hikes, inflation is easing without a big drop in demand. Consumer spending and jobs are healthy. The one caveat is that while inflation has come down, that does not mean prices have come down. Prices for many items, though rising more slowly this year than last, remain well above pre-pandemic levels and are not likely to return to where they were. Higher cost of living weighs on consumer sentiment.
Traditional Asset Class Returns Q4 2023
| Asset Class |
Benchmark |
Q4 |
2023 |
| US Stocks |
S&P 500 |
11.69 |
26.29 |
| US Gov't Bonds |
Bloomberg US Govt Intermediate |
3.97 |
4.30 |
| Cash |
Bloomberg US Treasury Bill 1-3 Mon |
1.38 |
5.14 |
U.S. Stock Market
2023 was a turnaround year for stocks. After finishing 2022 down over 18%, the worst calendar year since the 2008 Global Financial Crisis, the S&P 500 rallied 26.3% in 2023. After three consecutive months of negative returns, sentiment turned in November with the prospect of a soft landing and likelihood of interest rate cuts. The S&P 500 rose 9.1% in November and 4.5% in December.
Nine out of 11 GICS sectors posted positive returns for the year. Technology (+57.8%) was the standout sector, followed by Communications (+55.8%) and Consumer Discretionary (+42.4%). The technology-heavy Nasdaq Composite finished up 44.6% in 2023. Although the breadth of the market widened later in the year to include a majority of S&P 500 companies, much of this positive performance is due to the outsized influence of a handful of mega capitalization technology names. Namely, seven companies were responsible for most of the S&P 500's gains this year, propelled by enthusiasm surrounding artificial intelligence (AI): Apple, Alphabet, Meta Platforms, Microsoft, NVIDIA, Amazon and Tesla. Meanwhile, Consumer Discretionary was fueled by the tight labor market and strong consumer spending.
Another turnaround was the outperformance of growth versus value in 2023. Growth companies are generally expected to grow their sales and cash flows at a faster pace than the overall market. They can be young, unproven, volatile firms in innovative fields, many of which pay little to no dividend. The Russell 1000 Growth index finished the year up 42.7% compared to the Russell 1000 Value index, which was up 11.5%. For context, the Russell 1000 Growth index was down 29.14% in 2022 while the Russell 1000 Value index was down only 7.5%.
In a final reversal, the four best performing sectors of 2022 were the worst performers in 2023. Utilities was the biggest drag (-7.1%) followed by Energy (-1.3%), Consumer Staples (+0.5%) and Healthcare (+2.1).
Fixed Income
The interest rate rollercoaster ride that occurred throughout 2023 ended on an overall positive note for fixed income investors. These rate movements were driven by market expectations of future U.S. Federal Reserve policy decisions causing yields to rise and fall in accordance with overall sentiment. After an aggressive monetary policy cycle, investors were trying to closely interpret each publication of the Fed meeting minutes, inflation, jobs data releases, and policymaker press conferences to predict if we were in the “higher rates for longer” phase or closer to a turn in the cycle and interest rate cuts. The U.S. 10-year treasury hit a multiyear high yield of 5% in October, only to reverse sharply from mid-October to year-end as inflation data continued to decline and the jobs market showed signs of cooling. Indeed, the Fed meetings in November and December held policy rates steady. Furthermore, the December minutes showed a dovish tone, suggesting the end of the rate-hike cycle. An updated dot plot which illustrates Fed policymakers’ future estimates of interest rates also indicated cuts starting in 2024. Headlines from the Bank of England (BOE) similarly took a dovish tone predicting rate cuts in the near term. This news drove rates lower with the 10-year Treasury ending the year at 3.88%, nearly 0.70% or 70 basis points lower than the start of the quarter and exactly where we started the year.
As the consensus for 2024 has shifted towards imminent interest rate cuts through an easing monetary policy, we will continue to monitor and look to the Fed for further clarity. As always, we will maintain a disciplined process in order to achieve strong fixed income returns.
Diversifying Asset Classes
While diversifying equity asset classes underperformed the S&P 500 in 2023, there were pockets of strength, with Mid Cap and Global REITs outperforming the S&P 500 in the fourth quarter. Moreover, Managed Futures aside, all other diversifying equity asset classes were positive for the year.
In a welcome reversal from last year, all fixed income sectors posted positive returns in 2023. The U.S. credit market, both investment grade and high yield, were the top performers with credit spreads over treasuries reaching their lowest levels of the year in December. Typically wide or higher spreads would indicate investors have economic concerns, whereas, tighter or lower levels indicate a level of optimism for the future.
| Asset Class |
Benchmark |
Q4 |
2023 |
| US Mid Cap Stocks |
Russell Mid Cap |
12.82 |
17.23 |
| Foreign Stocks |
MSCI EAFE NR |
10.42 |
18.24 |
| Emerging Markets Stocks |
MSCI Emerging Markets NR |
7.86 |
9.83 |
| Managed Futures |
Credit Suisse Mgd Futures Liquid |
(-1.42) |
(-5.91) |
| Global REITs |
FTSE EPRA Nareit Developed NR |
15.29 |
9.67 |
| Global Infrastructure |
S&P Global Infrastructure |
10.94 |
6.79 |
| Gold |
S7P GSCI Precious Metal |
10.99 |
11.51 |
| MLPs |
Alerian MLP |
4.98 |
26.56 |
| Emerging Markets Bonds |
Bloomberg EM USD Sovereign |
9.74 |
10.39 |
| US High Yield Bonds |
Bloomberg US Corporate High Yield |
7.16 |
13.44 |
| Floating Rate Loans |
Credit Suisse Leveraged Loan |
2.85 |
13.04 |
| Long Bonds |
Bloomberg US Long Corporate |
14.01 |
10.93 |
Conclusion
2023 marked a recovery in both U.S. Equity and Fixed Income markets despite persistent, albeit declining, inflation. While the risk of a recession has faded, the evolving geopolitical landscape may cause uncertainty in the year ahead. Our disciplined approach to investing and asset allocation is designed not only to participate in market upswings but also to mitigate downside risk. As we begin a new year, you can rest assured that our portfolios are positioned to protect you throughout the changing economic landscape, and we encourage you to stay the course.
