2023 marked an inflection point for markets with strong gains across both stocks and bonds. The S&P 500, Dow, and Nasdaq generated exceptional returns of 26.3%, 16.2%, and 44.7% with reinvested dividends last year, respectively. Despite the market choppiness so far this year, the S&P has come full circle and is now only about one percentage point below the all-time high from two years ago. What drove these results and how could they impact investors in 2024?
Perhaps the most important lesson of 2023 for everyday investors is that news headlines and economic events don't always impact markets in obvious ways. Last year's positive returns occurred despite historic challenges including the worst banking crisis since 2008, rapid Fed rate hikes, debt ceilings and budget battles in Washington, the ongoing war in Ukraine, the conflict in the Middle East, cracks in China's economy, and many more. If you had shared these headlines with an investor at the start of 2023, they would probably have assumed there would be a worsening bear market or a deep recession.
Many asset classes performed exceptionally well in 2023
ASSET CLASS PERFORMANCE
Total Returns
Sources: Clearnomics, LSEG
Date range: January 2, 2007 to January 17, 2024
Past performance does not guarantee future results.
Why isn't that what happened? At the risk of oversimplifying, the key factor driving markets the past few years has been inflation. High inflation affects all parts of the markets and economy including forcing the Fed to raise interest rates, slowing growth, hurting corporate profits, dampening consumer spending, and acting as a drag on bond returns. This is exactly what occurred in 2022 but many of these effects reversed in 2023 as inflation rates improved.
The headline Consumer Price Index, for instance, jumped 9.1% in June 2022 on a year-over-year basis but only grew 3.1% this past November. Unfortunately for consumers and retirees, this does not mean that prices will fall back to pre-pandemic levels - only that they will rise more slowly. For markets, however, what matters is that the rate of change is slowing and that core inflation could gradually approach the Fed's 2% long-term target.
The Fed is expected to cut rates in 2024
FEDERAL FUNDS RATE
Target range lower limit
Sources: Clearnomics, LSEG
Date range: January 2002 to January 2024
Past performance does not guarantee future results.
Thus, the recession that was anticipated by markets a year ago has not yet occurred. While many still expect economic growth to slow this year, it's not unreasonable to suggest that the Fed could achieve a "soft landing" in which inflation stabilizes without causing a recession. This is why both markets and Fed forecasts show that they could begin to cut policy rates by the middle of the year.
What does this mean for the year ahead? If 2022 was characterized by the worst inflation shock in 40 years, leading to a bear market in stocks and bonds, 2023 saw many of these factors turn around. These trends could continue if the Fed does begin to ease monetary policy. Of course, much is still uncertain and investors should always expect the unexpected when it comes to market, economic, and geopolitical events. After all, markets never move up in a straight line and even the best years experience several short-term pullbacks.
The most important lesson for investors is to stay invested.
STOCK MARKET PULLBACKS
The number of 5% S&P 500 pullbacks experienced by investors each year
Sources: Clearnomics, Standard & Poor's
Date range: January 2, 1980 to January 18, 2024
Past performance does not guarantee future results.
So, while the past twelve months have been positive for investment portfolios, investors should not become complacent. Recent market events are a reminder that holding an appropriate portfolio is the best way for investors to achieve their long-term financial goals.