by Jordan Hucht, CFP®, ChFC®, AIF®

Q4 Review: The Powell Party

In a stark reversal of sentiment, the fourth quarter began with stocks and bonds reeling in fear of higher rates for longer, only to be reversed by Goldilocks economic data, leading Fed Chair Jerome Powell to ring the party bell by essentially validating the market’s hope that rate hikes are over and that cuts are coming.

This set off a wild end to the year, with stocks (as measured by the S&P 500) rallying 16% in just over two months and the yield on the 10-year treasury falling from just over 5% to 3.8%. For the year, the S&P 500 gained approximately 25% to end just shy of the all-time high, and bonds logged solid mid-single-digit returns.

It was the great year that no one predicted, in the absence of the recession that everyone predicted, proving (again) that investment planning predicated on popular prospective predictions is a poor path to portfolio prosperity. Now, I serve that word salad with a side of jest, but the essence of the statement is something we talk about all the time: favor discipline over emotion, tune out the noise, and focus on long-term results.

With 2023 now in the books, let’s recap the year’s action and examine what we should be watching in 2024.

2023 Recap

Coming into 2023, sentiment was very negative, as most pundits expected the Fed’s inflation medicine to come with a side effect of economic recession. Instead, inflation steadily declined with improvements on both the supply and demand sides, unemployment remained sub-4%, the economy grew, and corporate earnings were better than feared. This spawned hope that the Fed could thread the needle to orchestrate an economic soft landing, and the market responded accordingly with an enthusiastic start to the year. Notably, though, the majority of the gains in stock market were concentrated in a handful of the country’s largest technology companies (which, conversely, took it on the chin in 2022).

But as the year wore on and the economy proved far more resilient than expected, interest rates took off to the upside based on the assumption that the Fed would need to do even more to cool things off and bring inflation down to its 2% target. Fear of higher rates for longer, along with political turbulence in Washington and abroad, put the kibosh on the surge, and stock and bond prices retreated over the summer and into the fall.

The market, being the fickle beast that it is, then reversed course again at the end of October when economic data (most notably, inflation readings) came in better than expected, and investors refocused on the soft-landing narrative. This kicked off another climb in the S&P 500, while interest rates retreated sharply. And then Powell showed up to the party in December when he struck his most dovish tone in years and seemed to suggest that the Fed is done with rate hikes and expects cuts to begin in 2024. As the market rally resumed in the final quarter, it also broadened, no longer being driven solely by mega-cap tech stocks. Specifically, the Rusell 2000, a measure of small- and medium-sized US stocks, rallied a whopping 24% in the last 9 weeks of the year.

What to Watch in 2024

Does the way things ended in 2023 mean that it’s smooth sailing to new highs in 2024? If only it were that simple. Here’s where we stand:

After the steep climb to end last year, the S&P 500 now trades at just over 19 times this year’s expected earnings, and the yield on the 10-year treasury is hovering around 4%. For context, the average multiple on the S&P 500 over the past 30 years is closer 16 times earnings, and the average yield on the 10-year treasury over the same time period isn’t too far off at 3.7%. Taken together, this means that stocks are somewhat expensive on an historical basis. The primary counterargument to that conclusion is that if you remove the largest 7 companies in the index (which are arguably deserving of higher valuations), stocks really aren’t expensive. To be clear, I’m not arguing either way; instead, I’m suggesting that we should keep an eye on valuations and understand that sentiment and momentum often drive the markets in the short term, but fundamentals matter over the long term.

On the inflation front, significant progress has been made since the Fed began its rate-hiking campaign in 2022, but inflation is still above the Fed’s target rate. Specifically, the Fed’s preferred inflation measure (personal consumption expenditures, or PCE) stands at 3.2% as of the November reading vs the Fed’s target of 2%. To date, Powell has been steadfast in his commitment to reach the target level. After skewing his speeches hawkish since the inflation fight began, he came across more dovish after the Fed’s December meeting, even noting that the committee discussed future rate cuts during the session. In fact, the Fed’s current rate forecast is for 3 quarter-point cuts in 2024. Though this was celebrated by the markets, let’s remember that the Fed’s forecast is just a forecast, and one that has proved inaccurate in recent history. The bottom line is this: the market is currently priced based on the expectation that the federal funds rate will be meaningfully lower at the end of the year than it is now; if that proves wrong, a recalibration of valuations would be likely to follow suit.

Looking beyond markets and economics, politics are likely to be a big driver of headlines in 2024, with a presidential election in the US and heightened tensions around the world. On the US presidential election front, though the headlines and new coverage are sure to be abundant, history has shown that presidential elections aren’t overly consequential to financial markets. In fact, the S&P 500 posted positive returns in 20 of the past 24 presidential election years. That’s not to say there won’t be some volatility induced as the election nears; it’s more to say that market fears based on an impending presidential election are historically unfounded. On the other hand, I think that rising tensions around the world are worth keeping a closer eye on, as conflict escalation can have a real impact on economies and financial markets.

Overall, I’d sum it up like this: a red-hot ending to 2023 based on optimism that a monetary-tightening-induced recession will be avoided has brought us to a point where the stock market, as a whole, is on the expensive side based on historical metrics, and interest rates are more in line with historical norms and expected to be stable or decline as the year progresses. In my opinion, the burden of proof is now on corporate earnings to deliver and the Fed to follow a path similar to what was laid out in December. And, of course, we don’t know what outside forces could rear their heads this year and cause economic disruptions and market dislocations. Some amount of uncertainty is always a certainty. Financial plans and investment portfolios should be designed with that in mind.

And with that, I wish you a very happy new year!

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Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results.