Over the next few posts, we'll take a look at the State of the Markets. In this 3-part series, we'll focus on three key areas: how stocks performed in 2023 and what drove performance, where we are now, and what financial experts forecast for 2024.
Let’s begin by looking back at Wall Street analysts' initial predictions for the market’s performance in 2023, how stocks actually performed in 2023, and some of the factors that drove that performance.
How Did Stocks Perform in 2023?
The S&P 500 closed at 4769.83 at the end of 2023, a gain of 24.23 percent and well above the most optimistic expectations of the major Wall Street analysts.
In fact, as we can see, forecasts fell well short of how stocks performed. There may be several reasons for this. The first reason was that many observers and economists expected a recession in the first half of 2023. It never came. They saw higher interest rates and bond yields as depressing stock returns. Also expected by most experts and investors alike was the swell of AI, or artificial intelligence, enthusiasm. Few imagined the progress, widening interest, and implementation of AI. As AI developments unfolded, they sparked a powerful lift in technology companies, which buoyed the rest of the stock market. Stocks also benefited from falling yields as inflation decelerated faster than many had anticipated, leading to hopes of a Fed easing.
Despite periodic worries over the health of regional banks and episodic worries that the Fed may remain restrictive for longer than hoped for, stocks moved higher, closing strongly in the final two months of 2023.
Remember, the S&P 500 Composite Index is an unmanaged index that is generally considered representative of the U.S. stock market. Index performance is not indicative of the past performance of a particular investment. Individuals cannot invest directly in an index. Past performance does not guarantee future results. The return and principal value of stock prices will fluctuate as market conditions change. Shares, when sold, may be worth more or less than their original cost.
Also, forecasts are based on assumptions and are subject to revisions over time. Financial, economic, political, and regulatory issues may cause the actual results to differ from the expectations expressed in the initial forecast.
Let’s talk about some of the factors that led to this.
What Drove Market Performance in 2023?
After a disappointing 2022, stocks moved higher to start the year and continued higher for the remainder of the year outside of a few notable retreats.
I want to draw your attention to the plot points on the graph because they highlight the key storylines that drove the stock market in 2023. They come down to two broad themes: the track of inflation and the Fed. As you can see in the early part of the year, the Fed is still hiking rates in the face of still too high inflation. Nevertheless, the market is moving higher perhaps for two reasons–bargain hunting and anticipating inflation will moderate, and the Fed will eventually stop its rate hikes.
As we look at the data points later in the year, sure enough, inflation is coming down, and the Fed is now pausing on further hikes, so much so that by the December FOMC meeting, the Fed is signaling rate cuts for 2024. Of course, markets never move in a straight line. There were some hiccups in this advance. One was the so-called regional banking crisis in March and some backtracking on inflation progress in September and October. A relatively strong economy–and a jump in inflation–caused some concern in the fall that the Fed may not have room to ease, which is why we saw bond yields peaking in October. However, as inflation resumed its decline, by December, the Fed was comfortable signaling to the markets that rate cuts may be in the offing in 2024.
Finally, keep in mind that amid falling inflation, labor markets remained robust, and the economy was reasonably healthy, which raised hopes for a soft landing.
The S&P 500 Composite Index is an unmanaged index that is generally considered representative of the U.S. stock market. Index performance is not indicative of the past performance of a particular investment. Individuals cannot invest directly in an index. Past performance does not guarantee future results. The return and principal value of stock prices will fluctuate as market conditions change. Shares, when sold, may be worth more or less than their original cost.
Corporate earnings are one of the factors that drive stock prices over the long term. As the chart shows, the earnings growth for the S&P 500 companies appears to be emerging from what market watchers call an “earnings recession,” that is, when there is at least two straight quarters of negative earnings growth. As you can see, corporate profit growth decelerated in the three quarters preceding the most recent quarter of reporting–the third quarter 2023.
Overall, companies struggled in recent quarters due to rising prices and global economic growth slowdown. But Q3 was more encouraging as companies recorded positive profit growth for the first time since the third quarter of 2022, aided in large part by revived consumer spending. While the third quarter growth was welcomed, it was driven by just a few sectors of the economy. This narrow contribution to earnings growth is concerning, and leaves some investors worrying about the durability of earnings growth in the year ahead.
We already touched upon some of these economic numbers, but let's spend a little time getting a broader view of the economy in 2023.
This year, the word used by Wall Street and economists alike was "resilient." They remarked on our resilient economy, our resilient labor market, and the resilient consumer. As this table illustrates, the description is an apt one. With fresh interest rate hikes throughout the first half of 2023 on top of unprecedented rate hikes in 2022, many felt that these so-called "demand destruction" efforts by the Fed to lower inflation would do just that: reduce consumer and business demand by making purchases and capital investments more expensive.
While such rate hikes can take a while to work themselves through the economy, and whose lag effects may yet still be felt, the actual experience was that the economy grew at a respectable rate and is slated to expand nicely in the fourth quarter, and the labor market was strong beyond many experts' ability to explain it. All the while, inflation maintained its downward trend from its height in 2022.
The economy in 2023, however, had its issues. Consumer sentiment has remained low and stagnant. Though this seems paradoxical amid healthy economic growth and strong employment, consumers have been especially concerned about the high cost of goods and services. Many experts forget that the sharp run-up in prices of 2022 hasn't come down, even if today's inflation rate has. The reality is that despite disinflation, prices today are much higher than they were pre-pandemic, which has soured the mood of many Americans, especially those who are least able to bear the financial burden of higher prices.
We also see pessimism in the housing market, as reflected in the sentiment index of home builders. High mortgage rates and climbing home prices have left builders and prospective homeowners discouraged about the affordability of buying a new home.
These were a few of the factors that affected market performance in 2023. In our next State of the Markets post, we'll look at where we are now and examine the headwinds and tailwinds that could affect the direction of economic growth and financial markets in 2024. If you have any questions about the market, please contact one of our financial advisors today.
Sources for this post:
CNBC.com, May 11, 2023 https://www.cnbc.com/market-strategist-survey-cnbc/
February 1, 2023: Fed Hikes Rate 25bp https://www.wsj.com/articles/fed-approves-quarter-point-rate-hike-signals-more-increases-likely-11675278190
June 13, 2023: Inflation Hits 2-Year Low https://www.cnbc.com/2023/06/13/cpi-inflation-report-may-2023-.html
October 19, 2023: 10-year Treasury Yield Hits Closing High of 4.98% https://home.treasury.gov/resource-center/data-chart-center/interest-rates/TextView?type=daily_treasury_yield_curve&field_tdr_date_value=2023
December 13, 2023: Fed Sees Cuts in 2024 https://www.wsj.com/economy/central-banking/fed-holds-rates-steady-and-sees-cuts-next-year-4d554e9f
WSJ.com, November 5, 2023 https://www.wsj.com/business/earnings/breaking-down-the-best-earnings-quarter-in-a-year-a62ad2a8
TradingEconomics.com, December 14, 2023 https://tradingeconomics.com/
UMich.edu, December 14, 2023 http://www.sca.isr.umich.edu/
NAHB.org, November 16, 2023 https://www.nahb.org/news-and-economics/housing-economics/indices/housing-market-index
AtlantaFed.org, December 14, 2023 https://www.atlantafed.org/cqer/research/gdpnow
BLS.gov, December 15, 2023 https://www.bls.gov/