For reference, I am writing this earlier than I usually do, about two weeks before the end of the quarter, and barring any unforeseen events, we should close out the year on a very positive note. One rule I learned early on in investing that has served me well is “markets will do whatever they can to fool as many of the people as much of the time as possible.” With this in mind, the 4th quarter did bring a surprise by showing up with a "bad news is good, and good news is great" temperament. As an aside, please note that sometimes markets will trade opposite of this and see good news as bad, and bad news as horrible.
With the stock market slipping into this surprisingly positive trend – and coupling this with a recovering bond market as interest rates have fallen – the fourth quarter is providing a welcome finish to 2023.
As quickly as interest rates jumped in the third quarter, they retreated substantially in the 4th quarter. The 10-year Treasury yield started the 4th quarter at 4.68%, went as high as 5%, and as of this writing has dropped back to 3.91%.
To put this together, the equity markets are rising, and Treasury yields are falling with anticipation of the Federal Reserve not only being done with raising interest rates but hope that the Fed will begin lowering rates in 2024. However, the Fed is stating that it plans to keep rates elevated for an “extended period of time.” Time will tell.
As we look to 2024, we expect the economic slowdown to accelerate. Consumption could come under pressure as tighter lending standards and higher interest rates take a toll on borrowing. The silver lining is that this weakness could give the Fed the breathing room it needs to potentially begin reducing interest rates in the second half of the year.
The possibility of a recession is still on the horizon, and if we have one, it should be mild. One note of caution: With 2024 being an election year, be prepared for a more negative news cycle than normal about the economy as it weakens. It will probably sound much worse than it is. 2025 looks to be a stronger year with economic expansion resuming.
There are also signs of the next wave of inflation. Yes, you heard it here first. Labor costs remain an issue as the labor shortage is predicted to continue into 2025. Additionally, we reasonably expect continued government deficit spending, combined with renewed consumer spending, to elevate the risk of inflation rising again in 2025.
Looking ahead, we believe equity returns will normalize to mid-single-digits, given the run-up in 2023. It is rare that the equity market experiences back-to-back yearly performance like we just experienced. In fixed income, we expect to see appreciation in our positions as the Fed eventually pivots to lowering interest rates later this year.
As always, we will continue to take advantage of price fluctuations to add value to the portfolios.
If you have any questions, please let us know, and thank you for your trust.