What Has Changed for the Stock and Bond Markets From 2023?
The last quarter of 2023 was a wild one for investors. By the end of October, the S&P 500 index was down more than 8.5% from the July 31 high. Although the index was still up over 9% for the year, market sentiment had clearly soured on concerns of a “higher for longer” environment and what that might mean for the economy. But with the November Federal Open Market Committee (FOMC) meeting the sentiment changed and hopes were renewed for easier monetary policy on the horizon. By the end of November, the S&P 500 had made back most of the August through October losses and by the end of the year it was pushing new highs partially fueled by exuberant bets in the bond market on quick and significant rate cuts from the FOMC. The 10-year U.S. Treasury yield fell from just over 5% in October to under 4% by year end. Bond yields move in the opposite direction of prices, so that means bond prices climbed quickly in the last three months of 2023. Bond market investors were snatching up bonds in the expectation that yields would be lower soon. In short, everyone wants to get while the getting is good. So, we started 2024 two months into a powerful rally in both stocks and bonds with Fed Funds futures predicting a cut in interest rates as early as March and with an expectation of a Federal Funds rate below 4% by the end of the year. However, 2024 started with both stock and bond prices giving back some of those gains until last week when the S&P 500 finally made a new high for the first time since January 3, 2022, and then went on to climb some more. So, what explains all these swings in the markets?
Although the switch to a new year doesn’t fundamentally change economic data, the securities markets are made up of human participants and humans aren’t perfectly rational. The end of a calendar year is symbolic. It matters emotionally and sentiment is as much a driver of market performance as economic data, positive or negative. Everyone wanted 2023 to be a strong year of returns and so market participants enjoyed the euphoria of the Fed pivot through the holidays. However, with the new year upon us and calendar year 2023 returns locked in, January brought the need for a reality test of the sentiment through year-end. The market still expects rate cuts, but many participants have had to admit that a March rate cut isn’t a foregone conclusion. In truth, not that much has changed in the last few months outside of the implicit pivot from the Federal Reserve. While rate cuts haven’t started yet, it would take a significant change in the momentum of economic data for additional interest rate hikes to occur. Inflation is still on a downward trajectory and economic data is still chugging along.
What Are the Investing Risks in 2024?
There are always risks to investing – it’s the nature of the process. As we begin 2024, perhaps the most apparent risk is disappointment. Lofty expectations are priced into certain investments and if corporate earnings disappoint, or inflation disappoints by not falling fast enough, or the Fed disappoints by not cutting interest rates soon, then those expectations may need to be adjusted and prices along with them. Another event that some investors perceive as an investing risk is the outcome of the presidential election. The good news is that the historical data is positive for election years, and while past performance is not predictive of future performance, there also is no historical trend to suggest that a particular political party winning an election has a negative impact on stock market returns. In the 24 presidential election years since the inception of the S&P 500 index, 20 of them had positive total returns and the average return in an election year has been 11.6%. The year after an election has been more variable with only 58% of years posting a positive return, but still notching a 10.23% average return. That shouldn’t lead investors to expect a bad year in 2025 just because it’s the year after an election or to expect 11.6% return in the S&P 500 this year because it’s the average return in election years. As the saying goes, a picture is worth a thousand words.
S&P 500 Performance by Presidential Term, 1968 – Present
Only two of the last nine presidents left office with a negative return in the stock market and their successor oversaw a growing market. The four election years with negative returns were 1932, 1940, 2000, and 2008; the Great Depression, World War II, the dot-com bubble, and the global financial crisis. The truth is there are abundant factors that affect market returns and no single variable in isolation tells the whole story. Congress has a substantial impact on the passage of laws, each president inherits a different economic landscape than the last, and every four years bring new and different challenges and opportunities.
What Are the Opportunities in 2024?
Much like risks, the greatest opportunities in any given year may be ones we cannot predict. The development of AI was a major catalyst of stock market recovery in 2023 and it took many by surprise, not only the technological capabilities, but the impact on the U.S. economy. This year, the Federal Reserve could finally stick the landing and bring inflation down without a material economic slowdown and reduce interest rates to clear the runway for a lasting bull market. We could continue to see rapid advancement in the development of AI and expanded use cases for this technology that can improve lives and fuel economic growth. We could see novel technologies emerge that take us by surprise and create whole new markets to allow for innovative businesses to thrive.
The biggest risk or opportunity is often the one that no one sees coming. And while no one is kept up at night worrying about the next opportunity, the unseen risk is a bogeyman we could all do without. While it’s not possible to predict, it is possible to plan for this type of risk. The plan is to properly diversify a portfolio, honestly assess risk tolerance and set a suitable asset allocation, and then remind oneself why it was chosen when doubts inevitably arise in periods of volatility. Investing isn’t about predicting the future or calling the top or bottom of a given market cycle; it’s about carefully balancing risk and expected reward and understanding when risks rise or fall. That doesn’t dictate large portfolio allocation shifts, rather it helps us moderate emotional investing. Disciplined investing means not chasing the market, but not hiding on the sidelines either because both of those tactics can backfire. In the case of standing on the sidelines waiting for the perfect moment, money market yields, which are an investor’s return on cash, looked great through 2023 hovering around 5% mid-year. However, those yields will fall quickly when interest rates start coming down and stock and bond prices will have climbed as other investors moved from cash. There is a risk in being late to act. In the case of chasing returns, bitcoin looked great in late 2021 and tech stocks were all the rage in 1999, but most investors weren’t asking about those assets in 2022 and 2001 as prices reversed course quickly. Remaining invested in a diversified portfolio allows an investor to benefit from gains in parts of the market while managing the risk of one particular asset failing. If an investor feels the need to act, it’s valuable to ask both “what’s the best outcome?” and “what’s the worst outcome?” before making a move.
Ultimately, investing is the pursuit of optimists. To invest for the future, we must believe that we will see continued economic growth, that people will innovate, and that we will enjoy the fruits of our investment sometime later down the line. I, for one, do believe those things. I also believe the United States will continue to be on the forefront of that progress. We will overcome challenges and continue to pursue excellence and those pursuits will pay off. To be certain, 2024 will not be without challenges, but I look forward to seeing the successes as well. If you would like a more complete outline of our view on the current state of the markets, check out our 2024 Winter Market Outlook.
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