January 15, 2024
Happy New Year!
As we thought might be the case a year ago, 2023 turned out to be a good year for all sorts of investors. The feared recession never arrived, inflation has moderated, and we just might be done (for now) with the Fed tightening interest rates.
As is our tradition for this time of year, we will take a couple of pages to give you a blow-by-blow of the major asset classes in portfolios; what they have done, what we anticipate going forward, and how we have approached each. Whether you are a long-time client or a recent addition to our extended client family, we hope you will find this helpful.
In general, 2023 had bonds turning the corner from the broad declines of 2022 and many types of bonds had substantially positive returns for the year. While interest rate concerns kept pressure on the overall bond market for much of the year, a growing consensus that inflation was cooling set the stage for increasing bond prices in the 4th quarter as interest rates eased back from their mid-year highs.
For much of the year, the U.S. Federal Reserve continued its path of raising short-term interest rates to combat the damaging effects of inflation (after starting at 0.00% in early 2022, the Fed hiked rates 11 times since to end 2023 at 5.25-5.50%). Later in the year, inflation finally showed signs of decelerating, causing central banks around the world to pause their tightening pace.
Interestingly, the bellwether 10-year U.S. Treasury note saw an increase in yield from 3.9% at the beginning of the year to just above 5.0%, before falling back to 3.9% again by year-end 2023. From an asset class perspective, traditional bonds earned positive returns in the mid-to-high single digits, while floating-rate bank loans earned over 10%, seeing gains along with short-term interest rate increases.
International bonds marched to the same drummer that quickened the step of domestic issues, perhaps influenced more readily by the weaker economies in Europe and parts of Asia. International issues are also affected by currency concerns and a weaker dollar helped make the local returns apparent to US investors.
Corporate bond holdings in client accounts continued to be bolstered by the inclusion of floating rate securities which helped offset weakness in the bond market through the 3rd quarter. We did take action to reduce overall allocations to floating rate in November, emphasizing traditional corporate issues in their place. This was done due to valuations for bank loans having reverted closer to normal, as well as the likelihood of the Federal Reserve having moved closer to ‘peak’ policy rates, which lessens the attractiveness of variable rate instruments.
The U.S. stock market experienced solid gains in 2023, which included a routine -10% price correction in late summer, before recovering strongly in the fourth quarter. S&P 500 returns have been led by the ‘Magnificent 7’ group of stocks (Amazon, Apple, Alphabet/Google, Meta Platforms, Microsoft, Nvidia, and Tesla), while the remaining 493 firms in the index experienced solid, but less dramatic results. Within the Russell 1000 Index, which contains stocks of the largest large and medium-sized U.S. companies, ‘growth’ stocks sharply outperformed ‘value’ stocks, due to technology and communications influence, driven by strong fundamentals and excitement over artificial intelligence.
Value sectors remain heavily discounted relative to growth sectors in the universe of large company stocks. Additionally, while U.S. smaller company stocks underperformed large company stocks during the year, they remain valued at multi-decade lows relative to large company stocks, providing an attractive forward-looking investment opportunity.
As ever, diversification remains important, both by including different asset classes in your portfolio but also by diversifying different types of securities within an asset class.
Real estate, as characterized by the publicly traded Real Estate Investment Trust (REIT) marketplace, ended with positive returns, despite a high amount of volatility during the year. This volatility was primarily due to the expectation of rising interest rates, which have historically served as a strong headwind to real estate prices and financing over the short term. As interest rates fell back later in the year, prices recovered dramatically.
Fundamentals in the real estate asset class remain very divergent by property type, with office properties challenged in many urban downtown markets after the pandemic while segments such as data centers and cell towers have continued to benefit from rising digitalization trends.
We continue to believe that the inclusion of REITs in portfolios has a distinct benefit over medium and longer time horizons due to the diversification benefit they provide.
Commodities also experienced a significant amount of volatility in 2023, ending with slightly negative returns for the year. Crude oil prices falling by roughly -10% was the primary driver, with energy being the largest component of most commodity indexes. Geopolitical fears related to the Middle East faded, in addition to higher-than-expected supply conditions and fears over a slowing global economy weighing on potential demand. Industrial metals also fell back, related to weakness in China, while precious metals earned double-digit returns for the year.
Will 2024 give us the soft landing in the economy that we’ve all been hoping for? While this seems possible there are, as always, risks that remain. In 2023 we had quite resilient consumer spending, business investment was still robust, and an eventual stabilization of the housing market. Corporate profits grew more than expected as businesses were able to use pricing power and overall demand to boost revenues.
2024 may bring us more of the same, but perhaps not at such a robust level. Consumer spending may fall off a bit driven by a slightly weaker labor market, making businesses look more to controlling the bottom line with spending cuts. That said, it doesn’t appear that unemployment is set to rise steeply, at least not until the next recession, whenever that might be.
Overseas there is optimism that European and Asian economies will continue to rebound. While 2023 was led by India, Japan, and several Asian economies outside of China 2024 may see the Chinese economy respond more directly to their domestic stimulus measures. Europe as well may see a rebound in their economies following the sharp contractions they have experienced over the last couple of years.
There is certainly the potential for shocks as we look ahead. Geopolitical uncertainty, the US election cycle, and uncertainty about what the Fed will do about interest rates leaves room for a potential recession. The yield curve is still inverted with short rates considerably higher than longer-term interest rates. While short rates may come down through the year given the latest guidance from the Fed we’ll just have to wait and see when those rates cuts occur.
The Leading Economic Indicators were negative again in November when considered year over year, however, the 6-month numbers were less negative than they had been earlier. The Conference Board, those folks who maintain the LEI, do predict a shallow recession in the first half of 2024.
Looking at portfolios it is always useful to think about the seemingly perverse incentives that equity and bond markets respond to. Slowing economic growth may cause the Fed to cut rates more quickly than they might otherwise and lower interest rates are a direct contributor to higher prices for both stocks and bonds. While a shallow recession isn’t the best news from an economic perspective on Main Street it could cheer stock and bond investors on Wall Street if corporate profits hold up during that time.
Of course, there is no way for anyone to know what will happen this year in the capital markets, although there won’t be any shortage of pundits who will try to predict it. Most will be wrong, but a few will get lucky and there’s a difference between skill and luck. We understand this hard fact and address it by being diversified, patient, long-term investors who let our financial plans and appetite for risk drive our investment strategies. As such, this is a great time of year to consider your overall portfolio allocations in light of your financial goals and objectives.
We wish the very best for you and your family in 2024, and we want to thank you for your trust and confidence in us.
The Investment Team
Poulos Advisors, Inc.
Information and data contained in this newsletter was drafted and prepared in conjunction with Focus Point Solutions for use by Poulos Advisors. Focus Point Solutions and Poulos Advisors are not affiliated companies. The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities, and should not be considered specific legal, investment, or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk, and there is no assurance that an investment will provide positive performance over any period of time. The information and data contained herein were obtained from sources we believe to be reliable, but it has not been independently verified. Past performance is no guarantee of future results. References to market indices do not represent investible securities.