Well, I don’t want to jinx us but have you seen what the market has been doing lately? If you haven’t been following, Christmas came early this year. The week looks to finish strong with all three indices rising roughly 2.5%. And the cherry on the cake is the Dow Jones Industrial Average, the S&P 500, and the Nasdaq are all at a 52-week high as of this writing. As has been discussed previously, investors are one-hundred percent certain the Federal Reserve is done raising interest rates, and on the verge of pivoting to cutting rates as soon as the first quarter of next year. While that would be premature, in my opinion, even the Fed is on record saying it plans on at least three rate cuts next year. The next big catalyst will be that first announcement. Hold your hats when that happens.
So, what happened this week to drive investors into a frenzy? Simply put, it was a play in two acts. The first act was Tuesday’s release of the Consumer Price Index which edged up only 0.1% in November. It was primarily a case of lower gasoline prices which helped keep the headline number in check. On an annualized basis, inflation increased 3.1% which was below the 3.2% expected and the 3.2% prior month. The second act followed on Wednesday when the Federal Reserve announced for the third consecutive meeting that it would not raise interest rates. Perhaps more interesting is its summary of economic projections which signals more rate cuts for next year than previously forecast. The median projection for the federal funds rate at the end of 2024 now stands at 4.6%, down from 5.1% in its previous projection. These indicators suggest inflation continues to slow, the economy moves toward slower growth, and labor remains stubbornly tight. I believe the labor part of the equation will begin to normalize in the first half of 2024.
While the equity markets have been on a tear, you may have missed another development. Fixed income has also been doing particularly well these past few weeks. As it has become clearer that the Fed is at the end of its tightening cycle, investors have rushed to lock in yields at what will likely be the top of this economic cycle. All year we have been adding to our bond positions, and reinvesting maturing bonds at both higher coupons and higher yields with longer duration. This has paid off in multiple aspects. It means better returns, better cash flow, and the potential for appreciation as the Fed eventually pivots to cutting interest rates. Remember, there is an inverse relationship between bond prices and yields. As bond prices go up, the yield on that bond goes down. As we see yields plummet here, know that it means the value of the bonds in your portfolio are going up. And just to reiterate, yields are locked in at the time of the purchase of the bond (based on the price paid). We are delighted with the moves we made this year regarding fixed income.
One last thing I’d like to mention. While many parts of the market did well this year, i.e. technology, communication services (which is also heavily weighted in technology), and consumer discretionary, some parts of the market did less well. Among those are the parts that are more income-oriented, i.e. utilities, staples, real estate, and healthcare. As the Fed embarks on cutting rates (sometime next year), we would anticipate these underperforming parts of the market will do better. The competition from high-interest rates made dividend-paying companies less attractive this year. Next year that could reverse, particularly with the financial sector which should see higher net interest margins. Part of our process is to rebalance portfolios regularly to take advantage of the adage sell high and buy low. We saw some success with that in both the financial and real estate sectors toward the end of this year. I anticipate energy and healthcare will revert at some point in 2024 and we stand to see gains there too when that happens.
In closing, I know this time of the year can be difficult for some. Perhaps it was the loss of a loved one, or the mere distance between family that makes it impossible to come together. You should know you’re not alone. Researchers have discovered that artificial intelligence may also suffer from seasonal depression. It seems since late November, users have noticed ChatGPT becoming lazier. It apparently provided simple answers or refused to do tasks at all. Even OpenAI has admitted that there’s something wrong with its chatbot. The company posted, “We haven’t updated the model since November 11, and this certainly isn’t intentional. Model behavior can be unpredictable, and we’re looking into fixing it.” So, what’s going on? The hypothesis is that GPT-4 might perform worse in December because it learned to do less work over the holiday. Some are now speculating it is mimicking human behavior. I mean not me of course. Now you know.Bruce J. Mason, MBA