Taking stock of 2023 and looking to the year ahead.

Taking Stock of 2023 and Looking to the Year Ahead
2023 turned out to be a positive year for stocks.  This came as something of a surprise to the many economists and analysts who predicted the US would endure a recession at some point during the year.  And the well-documented sense of gloom pervasive in many segments of the country was at odds with significant evidence positive economic performance.  How people felt about the economy diverged from how the economy performed in actuality.  Investors who stuck to their long-term game plan were likely rewarded, while those who succumbed to their fears, however justifiable, probably underperformed.  What is going on?  Let’s consider.

The worry is understandable.
Most individual investors do not, with cold objectivity, sift through broad representative sets of data; they respond to what they see and hear around them.  And for many, what they saw in 2023 made them concerned.  Though composite measures of inflation came down a great deal throughout the year, the components that are daily encountered by the general public appeared to stay high.  Remember, inflation is a measure of the rate of change.  When inflation falls from say nine to three, the rate of increase slows but the actual prices reached might stay high.  Things like childcare payments, rent & mortgages, used car prices, and cost of groceries stayed high enough to cause a sense of “falling affordability” as described by WSJ reporter Dion Rabouin in a recent video. 

Cable news and social media don’t help.  Not to go too far down this media rabbit hole, but it seems that a lot of energy is put nowadays into generating outrage.  Outrage moves voters and is simpler to communicate than a balanced, sober, and pragmatic assessment of macroeconomic health.  I often believe I can tell which news outlets someone watches or what posts are presented through their social media feeds by what they say when I start to discuss the state of the US economy.  It can sound more like partisan talking points than considered analysis.

But the economy did relatively well.
It turns out that while so much seemed volatile, uncertain, and full of risk, the economy remained resilient.  We are near full employment, corporate earnings have held up, inflation has come down substantially, and interest rates have likely neared their high point.  Importantly, the rapid increase in interest rates did not appear to have had the dampening effect on consumers that was most feared by economists.  The economy seems less interest rate sensitive than in years past (for example, many people refinanced in recent years to low fixed rate mortgages).  Markets, having processed all of this uncertainty, decided upon optimism and surged to end the year near historic highs. 

Anyone can be excused for having misread the market’s potential for 2023.  The data one would traditionally examine to develop predictions were exceedingly hard to read.  There were no reliable apples-to-apples comparisons for data gathered during the COVID pandemic and the global response.  Indicators that in prior years may have been strong warnings of a coming recession, broke down in the pandemic aftermath.  Take the relationship in 2023 between rising interest rates and employment, for example.

Maybe the US economy is in fact durable.
Oftentimes when I talk with individual investors, I suspect we work from different basic assumptions.  Is the US economy fundamentally fragile or robust?  Many think we inhabit a fragile house of cards.  After all, we are awash in negative news, dire forecasts, and gross societal inequities.  It is perhaps an evolutionary inheritance for humans to approach the future with a measure of fearfulness.  It seems likely that fearful cave dwellers avoided dangerous nighttime predators while happy-go-lucky ones were easier prey.  But was our long-term success as a species due more to timidness or to adventurism and exploration?

One can describe the US economy as a giant dynamic ecosystem with millions of competing actors and sectors who thrive or decline as they seek their way to success and safety.  Shocks to the system, even very big ones, are often only a temporary setback, until the setback reveals itself in a new light as opportunity, and healing occurs.  Though the outcomes of markets and the economy can seem dispassionate, the actors that make up this system are anything but.  The US economy is comprised of many millions of humans: families, companies, non-profits, and individuals, all of whom strive each day to secure a better present and an improved future.  Some work in pure self-interest, others on behalf of others.  In aggregate, this is an awesome and powerful force, one I would not bet against.

Furthermore, we learn.  I know the system is imperfect and clumsy, to say the least.  But the lessons learned from prior failures, at least the more recent ones, are baked into the decisions and policies of today.  Take the catastrophes of the past thirty years: the bursting of the dot-com bubble, 9/11, the Great Recession, and the COVID pandemic each taught valuable lessons to investors, Fed Chairmen, corporate leaders, business owners, and policymakers.

What the market said in 2023.
If you look at the market as a dynamic system that processes massive amounts of information and over time responds accordingly, what then did it say about 2023?  We saw expressions of relief as companies and sectors recovered from dismal performances in the preceding year 2022.  We saw expressions of opportunism as a narrowly-focused surge in large tech companies came in response to AI innovations.  We saw fear during the late summer/fall as bearish investors worried that maybe things had gone too far too fast and the long-predicted recession might be upon us (it wasn’t).  Incidentally, this swoon from August through the end of October seemed especially disturbing to worry-prone investors – more so even than the bear market of 2022.  Finally, in the end we saw a powerful recovery where growth participation broadened across many sectors and asset classes. 

People read this past year’s market action in different ways of course.  But given that this growth occurred in the face of the draining of pandemic stimulus and severe monetary tightening (such as rising interest rates), I see evidence of robust durability.

Looking ahead: worry and optimism.
We step into 2024 with positive momentum which could give investors a sense of optimism.  I argue that investors should continue to take advantage of potential growth in various assets.  However, whenever the mood on Wall Street turns optimistic, I raise my hand to remind us to remain skeptical.  Not cynical or fearful, but skeptical.  Let’s take on risk, but with some caution as we do so.  There are plenty of potential catalysts to turn things negative for a time.

As I’ve said before, the markets from here could go up, down, or sideways.  Rather than betting all of your chips on any one outcome, investors should try to prepare for whatever outcome presents.  In 2024, we think this means a return to classic historical investment tenets:

• Asset Allocate using traditional asset classes of stocks, bonds, cash, and only some alternatives.  With interest rates likely near their peak, “long duration” investments like longer-term bonds and growth stocks could do well.
• Diversify Well within allocations across styles, sizes, durations, and regions.  Areas that underperformed in recent years may be queuing up to have their renewal: such as developed international and emerging markets due to “reshoring” and “near-shoring” efforts as well as a potentially falling dollar.
• If a sideways market occurs where growth is low, income-generating investments like dividend stocks, bonds, and REITs could provide valuable contributions to total returns.  And remember, sideways doesn’t necessarily mean stable; it could mean volatility of ups and downs that land the markets close to where they began the year.

And above all,
Be patient.  Good investors are thoughtful and curious, not reactionary and fearful.  These past four years have focused investors too much onto the immediate- and very short-term.  Speculators can try to take advantage of swings in the market by making huge bets that may/may not pay off.  Investors develop a careful plan, make adjustments after sober and careful consideration, and then let it all play out.  Good investments should prevail, eventually. 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. 

The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Stock investing involves risk including loss of principal.  Asset allocation does not ensure a profit or protect against a loss.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio.  Diversification does not protect against market risk.

The data included is developed from sources believed to be providing accurate information.