Wealth Management Insights

Year-end review 2023

Equities and bonds rallied in the fourth quarter of 2023, with the S&P 500 finishing the year less than 1% away from its January 2022 record close. Investors welcomed signals that the Fed’s rate hike cycle was nearing an end amid progress in bringing inflation closer to target levels.

At Nixon Peabody Trust Company, we continuously evaluate real-time economic data and short- and long-term forecasts to build customized strategies that grow your money. If the flood of financial headlines leaves you a bit confused, you can be confident that we’ve designed a portfolio-positioning strategy to maximize your success.

2023 in review

The S&P 500 rose 26.3% for 2023, helped by a rally of 11% in Q4. A small number of stocks were dominant performers in 2023. Bond prices rebounded in Q4, with the Bloomberg Aggregate Index gaining 7.5%. Ten-year Treasury yields fell to 3.9%, a significant rally from the October peak of nearly 5%.

Real estate and technology were the top-performing S&P 500 sectors in Q4; energy was the only sector with negative returns. For the year, technology and communication services were the best performers, while utilities and energy were the worst performers.

U.S. small company stocks surged in Q4 but still trailed large-cap stocks for the full year. International and emerging markets stocks rallied in Q4 but trailed the U.S. for the quarter and the year.

Consensus expectations are for the U.S. to experience a soft landing in 2024, with economic growth slowing but not contracting. A soft landing would likely lead to a year of slowing but positive economic growth, moderate corporate earnings growth, and high single-digit returns for stocks.

Recessions tend to occur more than 18 months after the first increase in a Fed rate hike cycle, so historical experience suggests that a recession is still a possibility. We think the market is underestimating the risk of recession but consider it likely that any recession would be mild. The recently released December jobs report showed growing employment and higher-than-expected wage growth, providing some support to the “soft landing” narrative.

Interest rates

Stocks and bonds surged in Q4 with the belief that the Fed’s tightening cycle was nearly complete. Updated guidance on Treasury issuance also contributed to a rally in long-term Treasuries, with forecasts of lower bond issuance than expected and a resumed bias towards issuing short-term rather than long-term Treasury securities. Investors begin 2024 expecting the Fed to aggressively cut rates, though the December jobs report may dampen rate-cut expectations. We expect the Fed to be less aggressive than the market expects, as easing too fast could reignite inflation, an outcome the Fed hopes to avoid. We do not expect the Fed to cut rates as dramatically as the market expects unless there is a major employment downturn or geopolitical event that threatens financial stability.

Inflation

Energy, housing-related costs, and goods prices are helping to bring inflation down from 2022 peaks. However, it may be more challenging to bring inflation down to the Fed’s 2% target with wage growth remaining high, energy costs vulnerable to geopolitical developments, and climate change a potential source of supply disruptions. Although the rate of change in inflation is getting closer to the 2% target rate, with the Consumer Price Index 22% higher than pre-pandemic levels, the higher level of prices for everyday goods creates financial stress for many households and may be an economic headwind in 2024.

Disruptive forces

Forecasts for equity returns in 2024 vary widely, but the consensus falls between 8% and 9%, slightly below the long-term average for the S&P 500. There are myriad events or disruptive forces that could cause returns to move materially above or below the mainstream consensus. Politics will be in the headlines throughout the year, with 40 countries expected to hold national elections in 2024. Elections in Taiwan, India, the United States, and the United Kingdom are among the most consequential for markets.

Artificial intelligence boosted segments of the market in 2023; in 2024, investors will be assessing the pace of AI adoption and gaining more insight into winners and losers in the AI race. The expansion of GLP-1 drugs from diabetes to obesity treatment was a disruptive force in 2023, boosting earnings for pioneering pharmaceutical companies while creating uncertainty for insurers and medical device manufacturers. As with AI, investors will be watching the pace of GLP-1 adoption in 2024 while continuing to evaluate winners and losers.

Portfolio positioning

We have reduced our holdings in some of last year’s big winners, as the prices of some are high relative to our expectations of future growth. We do own some of the “Magnificent 7” stocks (Apple, Amazon, Alphabet, Meta, Microsoft, Nvidia, and Tesla). Although the Magnificent 7 are richly valued, the valuations appear less lofty when considering expected cash-flow growth and profit margins. Some are more attractive than others, though we worry about the risk of disappointment given the stocks are widely held. Volatility often creates buying opportunities for long-term investors, and we added to holdings that are compelling investment options among the segments of the market left behind in 2023’s narrow rally. We are emphasizing stocks that can grow market share and participate in growing end markets. We tend to favor companies that may be more resilient in uncertain economic times, with strong balance sheets and cash flows.

We are active in making changes to our equity holdings outside the United States. Although non-U.S. stocks have trailed U.S. stocks during much of the past decade, there are bright spots found among the large universe of non-U.S. stocks. There are long-term opportunities among stocks that are global or regional market leaders, with our investments in international mutual funds and ETFs designed to take advantage of the opportunities available globally.

With inflation receding and interest rates at higher levels than has been the case for much of the past 15 years, high-quality short- and intermediate-term bonds are an important segment of investor portfolios. We are securing higher rates by selectively investing in intermediate-term bonds, as today’s high money-market rates may not last indefinitely.

If you have questions or comments—about your personal portfolio or any of the trends and strategies we’ve outlined here—please reach out to us or any member of your Nixon Peabody Trust Company team. We’re always happy to hear from you.