Economic Flash: Why Market Volatility Could Rebound in 2024 

January 2024

US Economy: Resilient…for now.

With December unemployment at just 3.7% and wage growth of 4%, the robust U.S. job market is so far helping the economy avoid a much-anticipated recession. Meanwhile, inflation per the CPI cooled to just over 3% annualized in Nov., even as retail sales (+0.3%) and confidence surveys indicated that U.S. consumers are increasingly optimistic. Dissonance continued, though, as the Conference Board Leading Economic Index fell for the 20th month in a row, and the Small Business Optimism Index remained at near decade lows.

US Stocks: Small-cap resurgence.

U.S. equities finished 2023 after nine straight weeks of gains, the longest such streak in more than six years, led by suddenly attractive small-cap stocks (+16.9%) and real estate (+11.4%). Still, roughly half of the S&P’s 26.3% return in 2023 was due to seven giant tech stocks; if equally weighted, the S&P 500 rose about half as much (13.8%). While easing U.S. inflation and good corporate earnings were tailwinds, the biggest driver is the potential for interest rate cuts by the Fed – futures pricing is indicating as many as six rate cuts in 2024.

Foreign Stocks: China, Japan lag.

Non-U.S. equities have also seen gains the past couple of months, although they have trailed U.S. markets. Asia has lagged as a region primarily due to weak performance in China (-2.4%) and to a lesser extent Japan (+4.4%), both of which have been notable laggards. In the case of China, the world’s second largest economy, investors have become increasingly concerned over business and household indebtedness and a fractured labor market creating headwinds for economic growth.

Fixed Income: Falling yields, big gains.

After soaring to roughly 5% in mid-October, the yield on 10-year US Treasury bonds sank to around 3.8% by year-end, triggering an exceptional bond rally of 8.9%, far exceeding performance in any other two-month period in the past 30+ years. As a result, the traditional portfolio of 60% stocks/40% bonds logged its best two-month return since 1990. Municipal bonds trailed due to their slightly lower interest-rate sensitivity, while emerging markets debt is outperforming on anticipated rate cuts.

Real Assets: REITs & infrastructure.

While commodities in aggregate were down roughly 2% in December, most real assets exposures, including infrastructure (+3.7%) performed well, boosting portfolio returns despite cooling inflation. REITs were the clear winner in the category again, as investors saw potentially lower interest rates leading to higher borrowing and re-energizing demand for real estate (office space in particular), a boon to office heavy U.S. REITs (+8.9%).

Alternatives: Mostly as expected.

Hedge fund strategies generally lagged traditional stock and bonds, which isn’t a surprise in markets pushed straight up by ebullient sentiment. We look to hedge fund strategies to provide portfolios with returns that are uncorrelated or lowly correlated with those of traditional markets. The lack of correlation is most beneficial in market environments with a bit less consistent market directionality, whether positive or negative.

Source of data: Bloomberg

Equities Total Return

U.S. Large Cap 4.5% 11.7% 26.3%
U.S. Small Cap 12.2% 14.0% 16.9%
U.S. Growth 4.8% 14.1% 41.2%
U.S. Value 5.9% 9.8% 11.6%
Int’l Developed 5.3% 10.4% 18.2%
Emerging Markets 3.9% 7.9% 9.8%

Fixed Income Total Return

U.S. Agg. Bond 3.8% 6.8% 5.5%
TIPS 2.7% 4.7% 3.9%
U.S. High Yield 3.7% 7.1% 13.5%
Int’l Developed 2.6% 4.8% 3.9%
Emerging Markets 1.7% 3.1% 7.2%
Intermediate Munis 1.6% 5.2% 4.3%
Munis Broad Mkt 2.4% 7.6% 6.5%

Non-Traditional Assets Total Return

Commodities (2.7%) (4.6%) (7.9%)
REITs 8.9% 18.0% 11.4%
Infrastructure 3.7% 10.9% 6.8%
Hedge Funds
Absolute Return 0.8% 1.3% 2.9%
Overall HF Market 1.5% 1.7% 3.1%
Managed Futures (0.8%) (5.2%) (3.5%)

Economic Indicators

DEC-23 SEPT-23 DEC-22
Equity Volatility 12.5 17.5 21.7
Implied Inflation 2.2% 2.3% 2.3%
Gold Spot $/OZ $2063 $1849 $1824
Oil ($/BBL) $77 $95 $86
U.S. Dollar Index 119.4 122.6 121.4

Glossary of Indices

Our Take

As we enter 2024, the more dire prognostications for the U.S. economy remain unfulfilled. Growth continues, inflation is slowly trending downward and the labor market hasn’t deteriorated meaningfully. It wasn’t for a lack of headwinds, given two major wars, three of the four largest bank failures in U.S. history, and the steepest interest rate increase in the past 40 years. As it turns out, U.S. consumers have continued to spend thanks to Covid-era excess savings coupled with significant wage growth (above 5%), as employers have been de-listing some of their job openings but not engaging in massive layoffs.

Does that mean the risk of recession has passed? Not necessarily. Given that the full impact of interest rate increases has yet to be felt, we could see weaker growth in 2024. Still, this is a U.S. Presidential election year, and we could easily be surprised on the upside, with the current administration doing all it can to support growth in 2024 and the possibility of the Fed lowering interest rates more aggressively than anticipated.

A Different Year in Many Ways

Yes, interest rates seem to have peaked, and this has fueled market optimism. However, while inflation and interest rates may drop from current levels, they are unlikely to return to the low levels we had grown accustomed to since the Global Financial Crisis. Our “higher for longer” thesis for inflation and interest rates is driven by the multi-polar geopolitical and economic landscape that is arising as we move away from a long period of global integration and post-Cold War cooperation.

This coming year, politics and geopolitics could be just as important as economics in determining market direction. In fact, that is the focus of our Q1 2024 Quarterly Commentary, due out January 18. Consider that in 2024, there will be highly momentous and contentious elections both in the U.S. and abroad: nearly 4 billion people in countries representing over 50% of global GDP are choosing new leaders, with major implications for markets and economies.

In terms of portfolio management, we completed our end-of-year review of strategic asset allocation ranges, including stress tests, and analysis of possible adjustments to take advantage of the improved risk/reward tradeoff for bonds and other diversifying investments. The results suggest our current strategic targets remain generally appropriate. Given that, portfolios that have benefited from the 2023 market recovery may now benefit from rebalancing to lock in gains and bring risk-reward characteristics back in line with targets.