Annual Observation -- Looking Back at 2023
Market Soars amid Recession Fears:
“Inflation”, “Recession”, “War” and “Interest Rates” are the four words that can be used to reflect the reality, or in the case of “recession”, the prediction, of 2023.? It seems like for the last year and a half, every time you threw on the news channel or read any articles that were published the forecast was the same— pain is coming to businesses and consumers alike.
In 2023, our country experienced the most aggressive monetary policy since the 1980s. Two different wars rage on in Eastern Europe and the Middle East. Geopolitical tensions between China and the US over Taiwan are tense. The yield curve has been inverted for over 17 months, which is commonly recognized as a leading indicator for contracting growth, or a recession (Yields are higher in the short term and drop as you go out 1, 3, or 5 years. This shows that the market is predicting expansionary monetary policy will be needed, or that interest rates will need to be lowered in the future to free up investment because of a contraction in the economy). Oh, and not to mention, our national debt burden is at levels we’ve never seen, people are pulling their money out of retirement accounts at the fastest pace we’ve seen in years, and credit card debt levels have hit an all-time high.
Nevertheless, the market soared. The S&P500 index finished up 24.23% on the year, within a percentage point of it’s all time high. The NASDAQ Composite finished the year up over 44%. The VIX Index, also referred to as the “Fear Index”, measures volatility in the market as a measure for how skittish investors may be. In the middle of December, it hit the lowest point we’ve seen since early 2020 before the pandemic. The Michigan Consumer Sentiment Index (MCSI) is a monthly survey of consumer confidence levels in the United States conducted by the University of Michigan. This index is up 23% from January to December of this year. All the while, recession forecasts have been consistently pushed back and have been become milder and milder over the past two years. Although the consensus still seems to be a mild recession in the middle to end of 2024, the flashing warning lights are significantly duller, and the conversation has shifted from deferring risk to bringing on risk.
Why?
There are a few reasons for the seemingly disconnect between forecasts of 2023 and the reality of 2023.
1.?????? Inflation is not just accelerating at a slower pace, but it has decelerated at a quicker pace than expected.
This year could be (and I’m sure, will be) used as a case study in any college macroeconomics course across the country. Monetary policy has always been reflected in the realm of Economics through simple charts, with just a few variables being able to sum up the economics behind monetary policy. As an Economics major, I became very familiar with these graphs at the University of Texas but never experienced the real-world implications of them myself. 2023 changed that.
Looking big picture, inflation is a result of a too much demand relative to supply. A few things that cause this imbalance are supply shocks (think back to the supply chain crisis of 2022), increases in the money supply (think back to COVID-19 stimulus), rising producer costs (material costs or labor costs), wage growth, and even future expectations. Raising interest rates decreases the money supply because consumers and business alike are being paid more (in the form of interest) to save. Thus, demand is lowered and since there is a smaller amount of people willing to pay higher prices, inflation comes down.
Woah, that’s a lot of fancy words. I always find it useful to really think about the money supply and why the Fed is trying to shrink it. Think of it like this, with a big picture perspective—if you have five dollars in your pocket and there are only 100 dollars total within your “system” (in this case, the US money supply), would your five dollars be more valuable or less valuable if there was 200 dollars in the system? Would you rather have 5% of the money supply or 2.5% of the money supply? Naturally, you would answer with the former.
1.?????? The Stock Market is a leading indicator, and thus is used as a prediction mechanism for the overall economy.
The first thing an investor must ask when trying to understand why the market goes up, is to understand why it was down in the first place (and vice versa). We must not forget that 2022 was one of the worst years for stocks alone since 2008 and the worst year ever for the classic “60/40” portfolio, which is meant to reflect the return of a portfolio consisting of 60% stocks and 40% fixed income. As decreasing earnings estimates and worsening consumer forecasts for this year were relayed in 2022, equity valuations dragged the market downwards alongside rampant inflation. At the time, monetary policy that was needed to bring down inflation seemed to pave the way for a “hard landing” of the economy and would almost certainly pull the United States into a deep and painful recession. This narrative, in addition to overvaluations caused by the influx of money into the economy after COVID, helped lead to massive losses in 2022. But the deep and painful recession of 2023 never surfaced. And as economists and investors alike have changed their tune throughout the year, the market has risen alongside elevated earnings revisions as the resilience of the US Economy stays on full display.
2.?????? The Job Market has stayed relatively healthy.
The past three years since COVID-19 has shown arguably one of the largest shifts in employment and participation in the job market ever. Off the top of your head, I am sure you can name a dozen colleagues or acquaintances that either “Work from Home” full-time or part of the time. Now think back to 2018…. other than those that are self-employed, how many people can you name that “Worked from Home” in any capacity? Had you even heard that phrase before?
My point is this—the culture surrounding work has changed dramatically, and not just in that way. The “Labor Participate Rate”, which is just a fancy word for how many people of working age are employed or looking for employment, remains low. A high number means that more people want to work. A low one means that less people want to work. Although this number has been rising, we can see on this chart that we are still not to pre-pandemic levels. Likely, 2020 caused some behavioral changes by really forcing us to think about what is most important in our lives—time with loved ones, travel, and having kiddos being only a few.
Although we have seen plenty of layoffs towards the end of 2022 and into last year, the employment rate has stayed healthy, despite the Fed trying to raise it. The goal of a higher unemployment rate is to slow down wage growth, and therefore slow down inflation. The December numbers showed a 3.7% unemployment rate, which is in line with the typical 3-5% numbers that is considered “healthy” for the economy. It is important to note that this number reflects the rate of those that are not working but want to be working. Those who are not working and do not plan to do so are not calculated into the Unemployment rate, thus furthering the importance of the large shift in participation rate.
1.?????? AI Growth and the “Magnificent Seven”.
Nvidia, Meta, Tesla, Amazon, Alphabet, Microsoft, and Apple were the biggest winners of 2023. What do all of these have in common? Yes, they’re all technology stocks, but even more important is that they all have significant stakes in Artificial Intelligence.
Whether they provide the physical capabilities for computing power through semiconductors (NVDA), are investing in autonomous vehicles (TSLA) or are developing their own forms of AI “in-house” for their existing platforms or systems (AAPL, MSFT, GOOGL, META. AMZN), there is no doubt that these companies will be leaders in the ever-increasing Artificial Intelligence space. At one point this year, these seven companies accounted for more than 40% of the entire SP500 index, which is composed of 500 stocks.
For the first three quarters of the year, the returns of these seven stocks accounted for the entire gain of the SP500 index. If you took them out of the index, the rest of the 493 companies had a negative return through the end of September. However, that changed in the fourth quarter. Participation across the entire market (i.e. the number of stocks that saw gains) increased dramatically in the fourth quarter, which is viewed as a bullish indicator.
Closing Thoughts
As a Financial Advisor, I get asked all the time—what do you think the market is going to do this year/month/week/next hour? My answers are always the same— I couldn’t tell you. 2023 was a great example of how it is dangerous to make predictions or expectations on the market, and even more dangerous to position yourself towards these views. If you would have listened to the folks on CNBC or every news channel towards the beginning of 2023, you would have sold everything and gone into cash. I mean, these are the highest yields we’ve seen in 15 years for cash, so it might have been intriguing to do just that. Oh, and you would have missed out on over 24% of gains that the market ended up achieving. My job and my team’s job are not to predict the market. Instead, it is to build long-term, sustainable portfolios that account for every client’s risk tolerance on an individual basis and to keep you invested. Our team and our clients are committed to the long-term excellence of the United States economy, using data and expertise to drive our decisions and not narratives.
It boils down to human psychology: if the market drops 20% and your portfolio is down 15%, even if you know that we are committed to the long-term and that the US stock market has gained back 100% of those unrealized drops over time, how well would you sleep at night? If the answer is not well, then we need to reevaluate your risk tolerance. If you’d sleep like a rock, knowing that downturns are healthy for the market (and not to mention great opportunities to build on existing positions or add additional positions to your portfolio), then we’re doing our jobs and the benefit will be seen exponentially in the long run.
I hope you and yours had a fantastic 2023 and I wish you the best of luck in 2024.
Written by Dillon Burr-- Raymond James Financial Advisor
Opinions expressed are those of the author and are not necessarily those of Raymond James. All opinions are as of this date and are subject to change without notice. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices generally rise. It is not possible to directly invest in an index. The CBOE Volatility Index? (VIX? Index?) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. The NASDAQ composite is an unmanaged index of securities traded on the NASDAQ system. Investing involves risk and you may incur a profit or loss regardless of strategy selected.
Image Sources:
Image 2: https://www.bls.gov/charts/employment-situation/civilian-labor-force-participation-rate.htm
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