By Paul Morrone, CFP®, CPA/PFS, MSA
It took nearly two years, but financial markets made it within spitting distance of the S&P 500’s all-time high (set 1/2/22) at the end of December. The rapid fourth quarter melt-up happened as buyers flocked back to the market en masse. While seasonality and the proverbial ‘Santa Claus’ rally that we traditionally see in December never hurts momentum, economic conditions and some powerful communication from the Fed were the sparks that lit the fire under markets during the last 9 weeks of the year. Much like the story for the past two years, markets have remained hypersensitive to the actions of our Federal Open Market Committee (FOMC) and the policies set forth after each of their meetings. Last year proved no different.
Unless you’ve studied finance in some capacity, the Fed may seem like somewhat of a rogue governmental entity. It is not one of the three branches of government, doesn’t have elected officials and is supposed to be politically agnostic – neither democratic nor republican. It does, however, have arguably the most critical function in all of economics, and its power in setting monetary and fiscal policy arguably exceeds that of even the president and congress, combined. Remember, it was the Fed who ultimately came to the rescue in 2008 during the Great Financial Crisis and again in 2020 during COVID as markets were going haywire.
The Fed also has the power to singlehandedly send the country into an economic tailspin, as evidenced by the tumultuous year of 2022 when rate raises brought our banking system to its knees and sent markets reeling. And let’s not forget the role the Fed played in the recessions in the late ‘70’s and early ‘80s. Point being, the Fed is very powerful, but not without good reason. For those that may not be familiar with why the Fed even exists, its mandates as established in the Federal Reserve Act of 1913 are simple and clearly stated, as follows:
“The Federal Reserve Act states that the Board of Governors and the FOMC should conduct monetary policy ‘so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.’ This statutory mandate ties monetary policy to the broader goal of fostering a productive and stable U.S. economy.”
I’ll say it again, the Fed is kind of a big deal. So, when Powell speaks, markets listen. It’s amazing to watch trading patterns when Powell takes the stage at 2pm, market movements happen in real time as a reaction to specific words that he uses in his public address. The reason? The decisions made on the FOMC reverberate through financial markets throughout the world, not just here at home. If you’ve ever wondered why investors live by the saying ‘Don’t fight the Fed,’ now you know.
Reinforcing the fact that markets will continue to not ‘fight the Fed,’ investors hit the buy button as economic data poured in from late October. What was believed to be the nail in the coffin for future rate hikes, the October economic data, released in November, showed inflation had slowed more than expected from both a month-over-month and year-over-year perspective, validating that the Fed’s aggressive tightening campaign was continuing to deliver as anticipated. Shortly thereafter, payroll and labor statistics reaffirmed that higher borrowing costs and tighter monetary conditions were beginning to take their toll on employers. After the November meeting Powell stated, “The labor market remains tight, but supply and demand conditions continue to come into better balance.” The inclusion of the word ‘balance’ was all investors needed to hear, and markets continued the party until the end of the year.
Unlike 2022, however, the story in 2023 was a positive one – and positive in a big way. Global equity markets rallied, and core fixed income posted its first positive calendar year since 2020 – a much needed reprieve after a dismal 24 months. The benefit of the rebound in bond pricing was multifold, with the obvious big one being the higher returns investors received. A secondary benefit, however, is the higher yields investors can receive on their fixed income investments in the current environment. Going into 2022, the 10-year treasury yield was less than 1%, at the end of 2023, it was over 4.75%. Interest payments are up, and those cash flows help to insulate investments if prices should move downward. Additionally, any future rate cuts may prove to be a tailwind as bond prices tend to increase as market rates decrease. All of this means that bonds are now in a more favorable position to provide the diversification benefit that so many advisors use them for – something that was lacking substantially in the post-Covid zero-interest rate environment.
So where do we go from here? Well, that is one thing we will be discussing during our upcoming virtual event on January 18th, and we encourage you to sign up (which you can do using this link: CLICK HERE) . For those that can’t make it, here’s a sneak peak of what we are looking at from an investment perspective:
- In the short term (next 3 months) – it would not be surprising to see a moderate pullback in equity markets as things ‘revert to the mean.’ The rapid rise in equity prices since December have put current pricing well above the trailing averages, at least from a technical standpoint. This is a healthy, and expected, event that could set the stage for a rally propelling US equities to new all-time highs later in the year.
- The Fed and Interest Rates – of course!
- Inflation or labor market surprises – While the trends lately have been favorable, they need to remain that way for Fed officials to remain confident in their decision to indefinitely pause, and subsequently cut, fed funds rate. These numbers will continue to pose a risk and will undoubtedly be watched closely by financial markets.
- Mega Cap Tech Stocks – we’ll be watching this sector closely given its dominant influence on broad market indices. These stocks have operated on a growth-at-all-costs basis for the past 15 years and we’ll be watching to see if investors begin to rotate out of these in favor of value stocks such as industrials or financials as the economic environment of 2024 is substantially different than we’ve seen since before 2008.
- War and Geopolitical Tensions – while a humanitarian crisis is nothing to quickly dismiss, markets seem to do so. These tend to be more of a headline or shock risk than a true systemic risk.
- The 2024 Election – As polarizing as politics may be in today’s day and age, the balance of power in Washington tends to have nearly zero correlation with market performance. Much like war, elections often offer more shock risk than anything.
As we kick off the new year, we hope that you begin to think about your financial resolutions as much as your physical resolutions (let me guess, you want to lose weight?!). Remember, the most powerful financial wellness tool we have is controlling what we can and understanding how our decisions now affect our lives down the road. That insight is invaluable in remaining financially independent throughout life.
From all of us here at US Wealth, we look forward to another exciting year filled with the unexpected. Wishing you and your families a happy and healthy 2024!