It was a year that defied expectations by many accounts. Most forecasts predicted that the US economy would enter a recession in 2023 as the Federal Reserve raised interest rates to fight high inflation. But the economy remained resilient, inflation eased, and the Fed declined to lift rates later in the year.
A year that many speculated would be lackluster for US stocks saw the S&P 500 post gains of 26.3% on a total-return basis. Global stock markets also bounced back after posting their worst year since the financial crisis. As measured by the MSCI All Country World Index, global stocks rose 22.2% even as geopolitical tensions increased, with war continuing in Ukraine and hostilities erupting in the Middle East.
US inflation continued to retreat from June 2022’s four-decade high of an annualized 9.1% with the rise then falling to 3.1% in November. After raising rates three times in the year’s first half, the Fed made only one additional increase later in 2023. Policymakers indicated they will likely continue to hold interest rates steady, despite inflation remaining above its 2% target. Against this backdrop, even while the broad economy remained strong, some sectors, such as real estate and finance, lagged. Higher interest rates dampened home sales and new development activity. In the financial sector, the rapid rate increases in early 2023 left some regional lenders, such as Silicon Valley Bank, in precarious financial positions, with the value of their long-term Treasury bonds sinking. Many nervous depositors withdrew their cash, resulting in three of the four largest bank failures on record (after Washington Mutual in 2008).
In Washington, politicians debated the US debt ceiling and government funding. The president and Congress eventually agreed to raise the debt limit in June, avoiding a US default. Despite the deal, Fitch downgraded its credit rating on US debt, citing the country’s rising fiscal deficits and “the erosion of governance” that has led to multiple clashes over the debt limit in recent decades. However, stock and bond markets seemed to take the news in stride, regardless of whether debt ceiling debates and credit rating downgrades dominate headlines.
Big Boost from Big Tech
Among the strongest performers in 2023 were technology stocks, recovering after a dismal showing in 2022. Much of the stock market’s gains can be attributed to just a handful of companies, recently dubbed the Magnificent 7. They were led by NVIDIA amid strong sales of its computer chips, as interest in artificial intelligence exploded. However, valuations for those seven stocks are quite high, making Magnificent 7 outperformance difficult to sustain.
Bond Rollercoaster
In the bond market, US Treasuries rebounded after posting their worst annual return in decades in 2022, with the Bloomberg US Treasury Bond Index gaining 4.1% vs. the previous year’s 12.5% decline. But it was not a smooth ride for investors. U.S. Treasury Yields climbed during 2023’s first nine months but plummeted during the year’s final quarter.
Despite rising bond prices generally, yields (which fall when prices rise) were higher than they have been for most of the past decade. The 10-year Treasury yield nearly touched 5% in October for the first time since 2007, before pulling back below 4% by year-end. For the entire year, the 10-year yield was lower than that of three-month bills, keeping the yield curve inverted. While many investors see yield curve inversion as a foreboding signal of a recession or stock market downturn, no US recession was declared in 2023.
What’s In Store for 24’?
Economic resilience in the US and elsewhere is helping boost the global outlook for 2024, but as investors learned last year, the only thing certain is that there will be plenty of uncertainties.
Many variables are in play for markets this year, from wars in Ukraine and the Middle East to questions around interest rates. Many are also likely to be closely following the upcoming presidential election in the US. It’s worth noting that the political party that wins the White House is just one of many factors investors consider when pricing assets and stocks have generally trended upward regardless of which party holds the presidency.
In the words of Nobel Laureate Merton Miller, “Diversification is your buddy.” Well said Merton. How to best do so is another question.
This article was adapted with permission from Dimensional Fund Advisors.
Kevin Kroskey CFP® | True Wealth Design | January 2024
Disclaimer: Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All investing involves risk including loss of principal. No strategy ensures success or protects against loss.
