The Big Picture

In the simplest of terms, 2023 was a magnificent year for the market! Of course, things weren't so simple. There were plenty of surprises in 2023:

• China's COVID reopening was a relative bust.
• There was a mini banking crisis in March that the Fed concluded needed its intervention.
• Kevin McCarthy (R-CA) was ousted as Speaker of the House by his own party's doing.
• The Federal Reserve raised rates four times in 2023, contributing to a collective 525 basis points of rate increases since the Fed started raising rates in March 2022, yet Q3 real GDP was up an astounding 4.9%.
• Israel went to war with Hamas following an October 7 terrorist attack by Hamas on Israeli citizens.
• The 30-yr fixed mortgage rate topped 8.00%.
• Bitcoin futures gained as much as 174%, soaring in part on the prospect of a spot bitcoin ETF approval.
• The 10-yr note yield, which started the year at 3.88%, hit 5.02% in mid-October, and ended the year at 3.88%.
• Seven stocks accounted for roughly two-thirds of the gain in the market-cap weighted S&P 500.
• Despite a protracted inversion of the yield curve and 20 straight monthly declines in the Leading Economic Index, the recession many people saw coming never came.

The latter was the most pleasant surprise for the market, matched perhaps by the improvement in inflation. The PCE Price Index was up 5.4% year-over-year in December 2022, but was up only 2.6% year-over-year in November 2023, aided by falling oil prices, which posted their first annual decline since 2020. The core PCE Price Index was up 4.9% year-over-year in December 2022, but was up 3.1% year-over-year in November 2023.

The inflation rate still has room for improvement, but it was clear that the trend became the market's friend in 2023, confirming that the Fed's policy tightening efforts were succeeding in bringing down inflation.

The added connection -- and, arguably, the most important connection -- is that the labor market remained solid, consumer spending persisted with surprising strength, and economic data overall substantiated the notion that the Fed could very well achieve a soft landing for the economy.

All Aboard

As 2023 drew to a close, the Fed made it sound as if it was on board with the market's thinking, declaring that it is going to proceed carefully with future policy decisions and that it had started to talk about the timing of when it should start removing some of its policy restraint.

The Summary of Economic Projections showed a median estimate of three rate cuts in 2024 versus only two rate cuts in the Fed's September projections. The market loved what it saw in the December projections but raced ahead on its own accord and priced in the probability of six (!) rate cuts in 2024. 

2023 was indeed a year of interest rate swings. January saw a downswing in Treasury yields only to be followed by a sharp upswing in February that got quickly reversed amid the banking crisis in March.

There were some gyrations into May before Treasuries, dealing with some angst about the budget deficit and the Fed keeping rates higher for longer, rode an escalator up to their high yield for the year by mid-October. They then took an escalator down into year-end, catalyzed by a belief that inflation will continue to moderate, and that the Fed is done raising rates and will pivot to a rate-cut cycle in early 2024.

That rapid descent in Treasury yields was precipitated by short-covering activity and positioning changes on the part of fund managers. The same rang true for the rapid ascent in stock prices in the fourth quarter.

The Scope of Magnificence

Before the fourth quarter, though, it was still a magnificent market, only the magnificence was rooted largely in seven stocks: Apple (AAPL), Microsoft (MSFT), Alphabet (GOOG), Amazon.com (AMZN), NVIDIA (NVDA), Tesla (TSLA), and Meta Platforms (META).

These seven stocks were stalwarts, bulwarks, and nothing short of extraordinary in their performance. Price gains for these seven stocks ranged from 48% to 239%. They were favored for their market-leading positions, their financial strength, their earnings outperformance, their AI exposure, and, frankly, the need for fund managers to keep up with benchmarks.

Their collective might was the basis for the outperformance of the market-cap weighted S&P 500 and Nasdaq 100 throughout the year.

At their lows on October 27, the market-cap weighted S&P 500 was up 6.9% for the year and the Nasdaq 100 was up 29.2% versus the S&P 500 Equal-Weighted Index, which was down 5.7% for the year, and the Russell 2000, which was down 7.2%.

But then, just about everything turned magnificent into year-end as interest rates dropped.

In fact, from the low on October 27 to the close on December 29, the S&P 500 Equal-Weighted Index and Russell 2000 were more magnificent than the market-cap weighted S&P 500, gaining 18.3% and 24.1%, respectively, versus a gain of 16.2% for the market-cap weighted S&P 500.

To be fair, the price-weighted Dow Jones Industrial Average showed some magnificence of its own in reaching a record high in December, climbing as much as 16.9% from its October 27 low, and the Nasdaq 100 stayed magnificent, gaining 19.1%.

The scope of gains across the market, and the speed at which they occurred, proved yet again the benefits of a systematic investment approach and the hazards of trying to time the market.

So Long 2023

To say that the stock market closed out 2023 with a full head of steam is an understatement. It went hard charging into year-end, driven by rate-cut hopes, short-covering activity, performance chasing, a fear of missing out on further gains, and a rush to increase equity weightings in investment portfolios.

There is a contention in some corners that the year-end rally pulled forward returns for 2024, which is to say returns in 2024 might be less than they could be had this rally not happened.

All we can say to that is, "we'll see." 

What we know about 2023 is that the economy's performance, the Treasury market's performance, and the stock market's performance surprised in a magnificent way for investors. It wasn't always easy to watch, but it is the endpoint that matters and there is a lot to celebrate there as we say so long to 2023.

--Patrick J. O'Hare, Briefing.com