December 2023
US Economy: Bumpier road ahead?
Despite the U.S. economy growing 5.2% in the 3rd quarter, key indicators suggest higher interest rates are taking a toll and rapid growth is not likely to persist into 2024. In November, we saw deterioration in a wide range of economic data: downward revisions to consumer spending, continuing jobless claims at the highest level in two years, durable goods orders down 5.4%, more debt that is past-due, ongoing weakness in real estate, and year-over-year core inflation holding steady at around 3.5%.
US Stocks: Exceptional rally.
A dramatic November shift in sentiment marked global financial markets, which had spent the bulk of fall shedding gains due to expectations for higher interest rates. With the U.S. economy showing more obvious signs of cooling and the Fed pausing on more interest rate increases, rates fell and the S&P 500 soared over 9%. This is the highest monthly gain since July 2022, behind the April and November 2020 market rebounds. Most sectors were positive, but rate-sensitive tech (+13.0%) and financials (+10.9%) were the largest beneficiaries.
Foreign Stocks: Weaker dollar benefits.
Non-US equities also got a boost in November, with U.S. dollar weakness a significant factor. As U.S. interest rate expectations fell abruptly, the dollar lost ground against major currencies. Dollar weakness added roughly 2% to equity returns in the emerging markets (+8.0%) and 4% in developed markets (+9.3%). European stocks (+11.7%) benefited from inflation in the region falling significantly, although the U.K. (+6.5%) was a laggard given its more tenuous economic outlook.
Fixed Income: Also exceptional rally.
Yields on 10-year U.S. Treasury bonds fell a dramatic 0.6% on an outlook for weaker economic growth and tame inflation. Consequently, core fixed income returned roughly 4% to 5% during the month, lifting results back into positive territory on a year-to-date basis. Corporate bonds (+6.3%) were the better performers as credit spreads tightened and U.S. companies took advantage of the opportunity to refinance pending maturities.
Real Assets: No inflation, no problem.
Gold (+3.0%) held on to its year-to-date lead in a category that has faced headwinds from falling inflation and lower economic growth. The recent decline in interest rates benefited other real assets much more, including REITs (+11.9%), utilities (+5.1%) and infrastructure (+9.7%), all of which derive much of their return from competitive yields. Commodities lagged, with the energy component (-9.1%) pulling down results on weak growth and smaller cuts to OPEC production than anticipated.
Alternatives: On the right side of the ledger.
While private market alternatives did not (and typically do not) price in immediate benefits from large market moves, hedge funds strategies generally trailed public markets in November, which is fairly typical in an environment marked by “risk-on” sentiment. Still, most strategies were up, especially long-biased (+2.8%) and convertible arbitrage (+4.1%). The notable exception was macro-oriented strategies (-1.5%), which tend to struggle when market trends shift.
Source of data: Bloomberg
Equities Total Return
| NOV | YTD | 1 YR | |
|---|---|---|---|
| U.S. Large Cap | 9.1% | 20.8% | 13.8% |
| U.S. Small Cap | 9.0% | 4.1% | (2.6%) |
| U.S. Growth | 10.8% | 34.8% | 24.6% |
| U.S. Value | 7.6% | 5.4% | 1.0% |
| Int’l Developed | 9.3% | 12.3% | 12.4% |
| Emerging Markets | 8.0% | 5.7% | 4.2% |
Fixed Income Total Return
| NOV | YTD | 1 YR | |
|---|---|---|---|
| Taxable | |||
| U.S. Agg. Bond | 4.5% | 1.6% | 1.2% |
| TIPS | 2.7% | 1.2% | 0.1% |
| U.S. High Yield | 4.5% | 9.4% | 8.6% |
| Int’l Developed | 2.7% | 1.3% | (1.7%) |
| Emerging Markets | 1.6% | 5.4% | 6.0% |
| Tax-Exempt | |||
| Intermediate Munis | 3.9% | 2.6% | 3.0% |
| Munis Broad Mkt | 6.4% | 4.0% | 3.9% |
Non-Traditional Assets Total Return
| NOV | YTD | 1 YR | |
|---|---|---|---|
| Commodities | (2.3%) | (5.4%) | (7.7%) |
| REITs | 11.9% | 2.3% | (2.8%) |
| Infrastructure | 9.7% | 2.4% | 0.2% |
| Hedge Funds | |||
| Absolute Return | 0.9% | 2.1% | 2.6% |
| Overall HF Market | 1.0% | 1.5% | 1.5% |
| Managed Futures | (3.5%) | (2.8%) | (3.1%) |
Economic Indicators
| NOV-23 | MAY-23 | NOV-22 | |
|---|---|---|---|
| Equity Volatility | 12.9 | 17.9 | 20.6 |
| Implied Inflation | 2.3% | 2.2% | 2.4% |
| Gold Spot $/OZ | $2036.4 | $1962.7 | $1768.5 |
| Oil ($/BBL) | $82.8 | $72.7 | $85.4 |
| U.S. Dollar Index | 120.6 | 121.2 | 123.5 |
Our Take
It’s important to remember that at any one time, investor sentiment can be driven by a handful of data points. These could boil down to the price of oil, inflation or corporate profits. Currently, the data points that matter most to investors are (1) U.S. monetary policy and (2) market expectations for interest rates. With fewer “hawkish” comments from the Federal Reserve and U.S. inflation continuing to slow by most measures, interest rates along the yield curve dropped in November and drove a rebound in equities as well as bonds.
The magnitude of investors’ change in attitude can be seen in this: At the beginning of November (per Bloomberg), derivatives markets were pricing in that the Fed funds rate would potentially increase one more time but would be net 0.7% lower by the end of 2024. Just a month later, the same estimates project no more interest rate hikes and a Fed funds rate that is 1.1% lower by the end of 2024. While that difference may seem marginal, it is meaningful to investors worried that the Fed would continue to raise rates “too far, too fast.”
The perceived pivot away from that narrative resulted in the S&P 500 posting a year’s worth of gains in just November and bond market returns moving back into positive territory year-to-date. In fact, the renewed investor enthusiasm led to the 2nd best month since 1985 for the classic 60/40 portfolio (60% S&P 500/40% Bloomberg Aggregate Bond index.)
November’s whipsaw performance is also a good reminder of the difficulties in timing markets: A moment of “Thanksgiving” for strategic investing and the importance of adhering to long-term asset allocations, especially during times of great uncertainty.
Where We Are Now
As we exit 2023, the markets seem to be pricing in a higher probability of the much-coveted soft economic landing. While we cannot predict the future, we posit it may be premature to believe the full impact of all the interest rate hikes and continued bank credit tightening have been fully digested.
In fact, one could argue that parts of the U.S. economy have been in recession. In manufacturing, the U.S. Purchasing Managers Index (the PMI) dropped below 50 in November 2022, signaling a contraction, and it has not risen above that level since. A more widespread recession is certainly still possible: Interest rates have risen so dramatically for consumers and businesses that it is hard to envision how we wouldn’t have retrenchment in spending and investment (e.g. capital expenditures) at some point. And recent consumer spending data has started to slip in the last few months as employment weakens gradually, despite the strong Black Friday and Cyber Monday results.
As we look forward, a potential recession in the near term does not sway us from our strategic view of the next several years: The continued transition to a new geopolitical and economic backdrop marked by a less globally integrated, more multipolar world. In this environment, inflation and interest rates, while lower than the most recent spikes, are likely to settle above the depressed levels experienced over the last decade. Neither a change in Fed policy nor optimism around U.S. economic stability are likely to disrupt this new regime from materializing.
Portfolio Positioning
We continue to think the longer-term risk/reward tradeoff has moved toward bonds and credit-oriented investments in traditional credit, private credit, and credit-based hedge fund strategies. Bonds, which have been among the poorer-performing asset classes in recent years, are well-situated for long-term, risk adjusted returns based on current income and potential for capital gains when interest rates fall. Similarly, while deterioration is just starting to manifest more clearly in corporate credit, the opportunity set continues to increase across sectors.
Additionally, now is the time to consider rebalancing equity exposures to long-term targets, given two major ongoing wars, a historic rise in interest rates, and 2024 replete with elections around the globe potentially bringing more uncertainty and volatility. While the taxation of realized capital gains needs to be a consideration when rebalancing, the proverbial tax-tail should not wag the dog. In other words, while minimizing taxes in portfolios is always a focus for us, this does not exclude disciplined rebalancing (trimming overweights, adding to underweights), a key lever in wealth compounding over time.
