Q4 2023 Market Commentary + Outlook

Aldrich Wealth Partner Nicole Rice and Chief Investment Officer Darin Richards provide quarterly market commentary and projections for the upcoming quarter. This conversation is accompanied by a deeper dive into market performance in the last quarter of 2023 and what to look forward to in 2024.

The S&P 500 rose 11.7% during the fourth quarter of 2023, finishing the year up 26.3%. Nearly all the underlying sectors of the index gained as markets were reenergized by falling interest rates and a strong economy. The Federal Reserve (Fed) held rates steady during the quarter and signaled the potential for cuts in 2024. International markets rallied on falling inflation data, with the MSCI EAFE posting 10.4% on the quarter. Emerging markets, as measured by the MSCI Emerging Markets Index increased by 7.9% in Q4, trailing developed markets as China continued to face economic headwinds to the post-pandemic recovery. As yields started to tick down, fixed income posted strong returns, with the Bloomberg US Universal rising 6.8% in Q4. As inflation trended downward throughout the quarter, the labor market and economy remained resilient, though consumers’ unsustainable spending habits portended a potential slowdown in GDP. Going forward, stocks and bonds are both anticipated to produce attractive returns as the Fed shifts to rate cuts and the US avoids recession.

The S&P 500 gained 11.7% in the fourth quarter of 2023, bringing the year’s annual return to 26.3%. The quarter started off bumpy, with weak job growth data and markets finishing near five-month lows in October. Markets quickly rebounded, however, with the unemployment rate falling, payroll increasing, and stocks notching the longest winning streak since 2019 throughout November and December. During this period, the S&P had its best day in over two years and the Dow hit an all-time high. Throughout the quarter, the Fed policy worked its way through the economy and mortgage rates hit 23-year highs, causing home sales to fall to 13-year lows as a result. Despite this, consumers continued to spend more on both goods and services while also saving less. Credit card balances hit all-time highs and consumers fell behind on auto loans at the fastest pace in nearly 30 years. Inflation continued to cool throughout Q4 and as the probability of interest rate cuts by the Fed starting in 2024 increased, stocks endured a rally as bond yields dropped.

All but one of the eleven underling sectors in the S&P 500 rose during the quarter. Real estate was the quarter’s top performing sector, posting 18.8%, as falling interest rates boosted real estate returns. Technology was the second-best performing sector, gaining 17.2% on the quarter on the heels of the magnificent seven. Conversely, energy was the only sector to post a loss on the quarter, declining -6.9% as oil demand and prices fell.

For the first time all year, small cap stocks outpaced large cap stocks in Q4. Growth stocks beat out value stocks in large and mid cap markets, but value overcame growth in small cap markets. Continuing Q3’s trend, small cap value stocks posted the best performance of the fourth quarter.

International developed markets followed suit with the US, declining in October but gaining in the following two months, with the MSCI EAFE Index finishing Q4 up 10.4%. Currency gains of over 4% for the euro and over 5% for the Japanese yen boosted international returns. Business activity in the Eurozone declined for the sixth straight month during the quarter and the purchasing managers’ index hit a 35-month low, marking the fifth consecutive month in contraction territory. Retail sales continued to fall and earnings disappointed. The poor economic data, however, encouraged the European Central Bank (ECB) to hold interest rates steady after 10 consecutive hikes. Inflation fell to the lowest level since July 2021 and stock markets rallied on this information while bond yields dipped. Despite the ECB’s higher-for-longer statement, investor optimism around early 2024 rate cuts grew, driving the Stoxx 600 (a benchmark for the broad European markets) to a nearly two-year high. The UK had less of a positive quarter, posting one of the lowest returns of the MSCI EAFE Index countries. Home prices continued their six-month fall and hit the largest annual decline since 2008 by the end of the quarter. Additionally, private sector business activity remained contractionary. However, positive data were published as well. Inflation fell more than anticipated throughout the quarter and the labor market remained tight as wages rose close to record levels while the unemployment rate remained unchanged. Within Japan, wages and consumer spending continued to fall and the yen weakened throughout the quarter. Tokyo’s core inflation rate accelerated for the first time in four months, but despite this, expectations for the Bank of Japan to continue its ultralow interest rate policy propelled the Nikkei 225 (a broad benchmark for the Japanese markets) to its best year since 2013.

Elsewhere, the MSCI Emerging Markets Index rose 7.9% throughout the quarter. China, the only country within the index to post a loss on the quarter, began Q4 with its previously largest property developer defaulting on its debt payments. Stocks then plummeted, offsetting all gains from the reopening rally that occurred earlier in the year. The housing market slump deepened throughout the fourth quarter and exports declined amid weaker global demand. Inflation continued to decrease, unemployment stayed steady, and Moody’s lowered its outlook on China to negative as debt levels rose. In December, industrial firm profits increased after 11 months of falling, but were not enough to enthuse economists as they predicted China’s GDP to slow in 2024 amid persistent property woes and growing deflationary pressures. Conversely, the six other most-heavily-weighted countries of the index posted over 10.0% gains on the quarter thanks to growing economies and a weakening US dollar. Mexico rose 18.6% during the fourth quarter while the Mexican central bank held interest rates steady, citing a robust economy, strong labor market, and ongoing disinflation. Brazil was also a winner in Q4, gaining 17.8%, thanks to the expansion of the agriculture industry and increased consumption. India rose 11.9% on the quarter as economists predicted robust economic growth in the coming years.

Over the fourth quarter of the year, both the Bloomberg US Aggregate Index and the broader Bloomberg US Universal Index rose 6.8% as the Fed held rates steady and investors predicted interest rate cuts in 2024. During the last two months of the year, the indexes recovered from loss territory, avoiding a third consecutive down year for the first time in history. Year-to-date returns for the indexes closed at 5.5% and 6.2%, respectively.

The yield on the 10-year US Treasury fell 0.7% during the quarter, ending at 3.88% after surpassing 5.0% for the first time since 2007 in October. The yield curve remained inverted, with the 2-year yield persisting above the 10-year yield. Short duration yields, which are closely tied to Fed rate moves, fell too, with the 2-year treasury declining 80 basis points and ending the quarter at 4.23%. Although inverted yield curves tend to indicate recessions, it seems that the Fed may have navigated a soft-landing, as investors price in impending rate cuts.

US gross domestic product (GDP) grew at an annualized rate of 4.9% over the third quarter of 2023, the latest period for which data are available. Consistent with the year’s trend, consumers spending on both goods and services drove this increase. Simultaneously, consumers saved less, as personal income and the share of income Americans saved decreased. Credit card balances hit all-time highs and consumers fell behind on auto loans at the fastest pace in nearly 30 years, indicating that consumers may struggle to maintain this level of spending in 2024.

After a slight weakening in October, the labor market once again proved resilient and ended the quarter on an uplifting note. At the beginning of the quarter, job openings fell to the weakest level in over two and a half years and the unemployment rate ticked up. This was seen as good news for the Fed, who had been waiting for signs of the labor market turning over without disrupting the economy. Later in the quarter, hiring increased and jobless claims fell. December’s jobs report reflected a robust labor market, and the market rallied on job openings surpassing economists’ expectations and the unemployment rate holding steady.

Inflation maintained its downward trend in Q4. Throughout the quarter, the Consumer Price Index, a key inflation measure, continued to come in lower than anticipated. The Producer Price Index, an inflation measure for domestically produced goods, posted its largest monthly decline since April 2020 and the probability of another interest rate hike declined to essentially 0.0%. Consumer inflation expectations fell, and the Fed indicated three rate cuts in 2024, inciting a drop in bond yields and a rally in stock markets.

Arguably, the Fed may have been able to thread the needle between lowering inflation and maintaining economic stability. Markets sold off sharply in 2022 in anticipation of a potential recession and higher interest rates. In 2023, the economy continued to grow despite the highest interest rates in nearly 20 years. Inflation trended lower and the Fed signaled the end of the rate hiking campaign and the potential for cuts in 2024. If the US avoids a recession, it is reasonable to assume that domestic stocks will reprice higher as they already priced in a recession. Therefore, there seems to be limited downside assuming the economy continues to expand. International equities are buoyed by relatively attractive valuations and lower interest rates compared to the US. The end of Fed rate hikes may prompt the dollar to decline further from recent highs, which would be supportive of stronger returns overseas.

Emerging market stocks are trading at the most attractive discounts since 1999 and several countries have already started cutting rates as inflation has declined. Growth is expected to remain stable in 2024, which could lead to a recovery in emerging markets, but investor sentiment is tepid as China struggles to hit its growth target. However, a strong rally in countries outside of China in Q4 was promising and if China can effectively navigate some of its issues a broader recovery in emerging markets could provide attractive returns.

Bond yields are likely to remain fairly stable now that the Fed has proposed rate cuts in 2024. Longer term rates peaked in October before falling abruptly in the last two months of the year. Fed Chairman Powell struck a more dovish tone and yields fell and expectations for rate cuts increased.  The futures market is pricing in cuts of 1.5% in 2024, double the Fed’s estimate. Inflation and employment data in the coming months will provide insight into how quickly the Fed will initiate rate cuts. Bond returns look attractive for 2024 as yields are just below the highest levels since 2007 and additional rate hikes are unlikely.

This information is for educational purposes and is the opinion of Aldrich Wealth LP (“Aldrich Wealth”).  Facts and figures are believed to be from reliable sources, but no liability is accepted for any inaccuracies. Nothing in this commentary should be construed as an investment recommendation. Past performance does not guarantee future results and all investments involve risk. Aldrich Wealth is an investment adviser registered with the US Securities and Exchange Commission.