Year in Review

After plenty of ups and downs throughout the year, financial markets turned in reasonable results in 2023 – a globally diversified stock portfolio was up 16%, a reasonable proxy for bonds (Barclays Aggregated Bond Index) returned 6%. News on several fronts helps to explain this year’s results:

Interest Rates, Inflation and Prospects for a Soft Landing

Throughout 2023, all eyes were on the Fed’s effort to tamp down inflation without a recession. Much uncertainty was associated with its ability to pull this off. During the year, the Fed raised its Federal Funds Target Rate by 1% to 5.5%, which seemed to have the desired effect, as the annualized change in the Consumer Price Index (CPI) fell from almost 7% to 3% by the end of the year. Unemployment remained at historical lows in a growing economy suggesting a soft landing – not the conventional wisdom at the start of the year.

Stocks responded positively. The tech-ladened S&P 500 was up over 26%; domestic small company stocks (Russell 2000) up 17%; international developed markets (EAFE Index) returned 18% and emerging markets (MSCI Index) 10%.

Bond yields fell back in response to expectations that the Fed is done raising interest rates. The yield on the closely watched 10-year Treasury Note fell over 100 basis points (1%) from its October peak. Yields are now about where they were at the beginning of the year, producing returns for Treasury securities of about 4% across all maturities.

Artificial Intelligence and the Magnificent Seven

News on Artificial Intelligence (AI) impacted financial markets positively. Amid the short-term uncertainty, it is clear the impact of AI will be profound. Domestic tech companies expected to benefit from AI, termed the “Magnificent Seven” (Apple, Amazon, Google, Meta, Microsoft, Nvidia and Tesla) representing 30% of the value of the S&P 500, were up big in 2023. An equally weighted portfolio of these stocks more than doubled over the year.

Interest rate risk and bank failures

Rapidly rising interest rates from near zero means banks are susceptible to interest rate risk by funding long-term loans with short-term liabilities. This risk explains the failures of Signature Bank and Republic Banks, as well as increased concern for the banking system in early 2023.

Political upheaval

We have endured our share of political upheaval in 2023, including the ongoing fighting in Ukraine, the brutal attack by Hamas and Israel’s response, coupled with the ongoing dysfunction of our Congress. This political wrangling and global uncertainty, plus a three-year increase in the average price of goods in the CPI of 17%, helps to explain the public perception of the domestic economy generally being worse than what’s implied by the numbers.

What’s Ahead in 2024

The beginning of a year is when we are treated to various forecasts of what’s ahead. Don’t pay any attention – no one knows. A long history of market behavior does give us a sense of what’s expected, but what’s realized is driven by surprises, both positive and negative. Market prices are the best predictor – diversification is the best way to deal with uncertainty. Take advantage of the wonders of compound interest by maintaining established commitments to several markets and avoid getting caught up in anyone’s predictions.