Investment Review for Fourth Quarter 2023

Risky asset returns.

After suffering losses in 2022, risky assets recorded substantial gains in 2023.  Stock returns were impressive across the globe with U.S. large companies (as measured by the S&P 500) gaining the most at 26.3%, followed by 18.2% for large foreign developed companies, and 9.8% for emerging market companies.  

Gains for the S&P 500, however, were dominated by seven large companies.  Nicknamed the “Magnificent Seven”, these companies had an average return of 49.0% in 2023 while the other 493 companies had an average return of 13.2%.  As such, investor returns for U.S. stocks varied greatly from one portfolio to another.

Consumer prices.

Over the past 30 years, inflation, as measured by the consumer price index, has averaged 2.5% per year. As a result of pent-up demand, excess fiscal and monetary stimulus, supply chain issues, geopolitical stress, and a tight labor market, inflation has been running higher than normal over the past few years.

When looking at monthly data, inflation began rising modestly in early 2021 and continued to accelerate towards 8% before the Federal Reserve responded in March 2022 with its first interest rate increase.  If we fast forward several months and 11 interest rate increases later, inflation appears to be moderating.  With the most recent three readings below 3.5%, consumer prices remain elevated, but the pace of price increases has slowed substantially.      

The direction of interest rates.

As mentioned earlier, the Federal Reserve increased interest rates 11 times, bringing short-term interest rates to a little below 5.4% at year-end.  That upward trend, however, appears to be over.  Based on comments from Federal Reserve participants, as well as information displayed on their Summary of Economic Projections, the Federal Reserve could lower interest rates by 0.75% in 2024.  

Financial markets, however, believe the Federal Reserve will cut more aggressively than they have indicated and are pricing in an 87% probability of at least a 1.0% reduction and a 59% chance of at least a 1.25% reduction by year-end.   

Longer term interest rates.

With the expectation that the Federal Reserve would be cutting short-term interest rates in 2024, longer-term interest rates began to fall in the fourth quarter of 2023.  The 10-year treasury yield, which was less than 1% during the COVID lockdown, rose to a high of 5% in October of 2023, before falling in the fourth quarter to less than 4%.  

Similarly, 30-year mortgage rates rose to nearly 8% during 2023 before falling in the fourth quarter to 6.6% at year-end.  While a 6.5% mortgage rate is not high when looking at longer-term historic averages, there is a generation of home buyers who perceive anything above 4.5% as expensive.  As such, individuals with low mortgage rates are reluctant to move, while those looking to buy are reluctant to lock in a 30-year mortgage where rates are today.

Economic growth.

Economic growth was positive for the first three quarters of 2023, ranging from an annualized rate of 2.1% to 4.9%.  Fourth-quarter data has yet to be released, but the most up-to-date estimate from the Atlanta Federal Reserve Bank indicates a 2.2% annualized growth rate.  This is welcome news for an economy that has been fighting inflation and rising interest rates.  

Economic growth in 2024, however, may be a bit softer if the Leading Economic Index proves correct.  This index, published by the Conference Board, can provide an early indication of significant turning points in the business cycle and was designed to provide information on where the economy is heading in the near term. Recently, this index has been negative, which would indicate a softening of the economy may be on the horizon.