Market Summary: 2023 Year in Review
All asset classes rallied in the 4th quarter of 2023, adding an exclamation point to a generally positive year for investors. The U.S. economy shrugged off predictions of a recession, or at least was able to defer it to a later date. Interest rate increases had already ceased in 2023, but hints of rate cuts in 2024 propelled equity and fixed income prices higher. After reaching nearly 5% yield in Q3, 10-year Treasury bond yields dropped sharply in the fourth quarter to help bond prices recover and avoid a third consecutive year of losses.
|DJ U.S. TOTAL STOCK MARKET
|MSCI AC WORLD EX-USA
|BLOOMBERG U.S. AGGREGATE BOND
For most of 2023, U.S. stock valuations remained fairly reasonable compared to their long-term average of 16.59x price to earnings. By the end of the year, forward P/E multiples nearly reached +1 standard deviation, signaling an optimism for earnings growth or expectations that the Fed would lower rates sooner than expected. If the Fed doesn’t deliver on lowering rates early in 2024, then earnings need to grow to sustain this rally.
A couple of significant events happened in 2023 that need to be reviewed. I believe one of them may be resolved, but the other is still on-going issue that might trigger more disruptions to the global economy. Starting with what I think is the resolved situation, the banking system faced a serious crisis when several major banks failed and needed to be rescued or merged. Lower interest rates and rebounding bond prices may help banks’ balance sheets avoid more unrealized losses. It was also a wake-up call for other banks to be more diligent about their liquidity.
The second event is an unresolved conflict that started on October 7th when Hamas militants attacked Israel, prompting a devastating retaliation on Palestine. That was the first domino to fall. It inspired the Houthis, an Iran-backed rebel group, to attack and hijack commercial ships in the Red Sea. Those waters and the Suez Canal are a key route for ships to deliver goods and fossil fuels between Asia and Europe. Rerouting ships around Africa adds significant costs and delays, possibly disrupting global supply chains. Iran is an oil producing country and they support the Houthis, so there’s a concern that they may inspire an oil embargo reminiscent the events in 1973. During the 1973 Arab-Israeli War, Arab members of the Organization of Petroleum Exporting Countries (OPEC) imposed an embargo against the United States in retaliation for the U.S. decision to re-supply the Israeli military. Even if domestically we don’t have gas shortages, an oil embargo will have serious consequences of rising fuel costs, which then affects the price of food and goods.
The equity market started 2024 on a positive note with the S&P 500 and Dow Jones Industrial Average reaching all-time highs and the NASDAQ Composite nearing its peak. The fed funds rate has held steady since the summer of 2023 with an unlikelihood of more rate increases as inflation stays muted at 3.4%, as measured by the Consumer Price Index. Unemployment remains a historically low 3.7% as the U.S.’s Q4 GDP increased at a 3.3% annualized growth rate. All the numbers seem to set the stage for investors to have a good year, but now let’s review the potential headwinds.
News of corporate layoffs have become a daily occurrence, seemingly focused in the technology sector. This could just be an unwinding of the massive amount of tech hires over the past decade or it could be a bellwether for more layoffs that affect the broader job market. In our 2023 Q3 newsletter, we wrote about “The Rise of Artificial Intelligence” and mentioned the growing trend of A.I. but didn’t discuss the possibility of this technology taking away jobs from humans. Although these recent layoffs are unlikely to be attributed to A.I., this could very well be something we have to contend with in the near future.
As mentioned earlier, tensions are rising in the Middle East while other major conflicts in the world have yet to be resolved. And to add more uncertainty to the situation, we are in a presidential election year. Put it all together and we might see more volatility through the rest of the year.