Markets defied analysts’ gloomy projections for 2023, rallying into the close of the year and generating solid gains for investors.  It is a welcome performance that exceeded expectations, and one that required markets to overcome dramatic headwinds that included aggressive rate hikes by the Federal Reserve, a financial crisis that toppled some prominent regional banks and another war breaking out in the Middle East.  By the time holiday season was in view, stock prices shook off their summer slump and went for a nine-week run, the longest rally in about 20 years.

We have likely seen the peak of this interest rate cycle.  When the Federal Reserve began raising rates in March of 2022, inflation was enemy number one for our economy.  Tighter monetary policy, which included 11 rate hikes that pushed rates upward by a total of 5.25 percent, was designed to tame runaway prices.  Demand cooled as the cost of borrowing money got more expensive for corporations and individual consumers. Inflation is now well on its way back down toward the Fed’s target of two percent.  After the most recent meeting in December, Fed Chair Jerome Powell acknowledged they are likely done with rate hikes, and he suggested the next phase of monetary policy could include three interest rate reductions in 2024 as prices continue to stabilize.

Calming interest rates are good news for a financial sector that took some hits this past year.  Higher rates put pressure on the value of loan portfolios held at banks, causing losses that startled depositors.  Back in March, First Republic Bank, Silicon Valley Bank and Signature Bank became the second, third and fourth largest bank failures in our nation’s history.  The FDIC chose to protect all customer deposits, even amounts over the $250,000 coverage limit, which stemmed the bank runs and averted a broader catastrophe.  Pressure on loan portfolios intensified as yields on 10-Year Treasury securities inched upward to five percent by October, their highest yield in 16 years.  Banks got some relief as rates began to recede, with the 10-Year Treasury closing out 2023 with a yield of 3.86 percent.  Rates on traditional 30-year mortgages, which had surged to around eight percent, are now falling back to around six percent, offering some encouragement to a beleaguered housing market.

World events have been difficult.  Russia’s battle with Ukraine was already in its second year when Hamas invaded Israel on October 7.  Tense developments with China, Russia and Iran further complicate a political landscape that has weakened U.S. influence and diplomatic efforts.  Iranian-backed Houthi militants have disrupted shipping in the Suez Canal, a key trade route between Europe and Asia that connects the Red Sea to the Mediterranean, and there have been more than one hundred attacks on U.S. troops in Iraq and Syria in recent weeks since the escalation of conflict in Gaza.  Instability around the globe raises the stakes for yet another divisive election year in the U.S., with voters understandably weary of partisan scandal, corruption and ineffectiveness among our elected officials.

For now, the capital markets appear to be tolerant of disruptive political events and more focused on the encouraging prospect for improving interest rates and corporate profits.  Various indices that represent stock prices all portray a solid, if not exemplary, performance for 2023.  The S&P 500 Index gained roughly 24 percent, buoyed by remarkable gains for seven large technology companies that have grown to represent an historic 30 percent of the index.  Collectively, these “magnificent 7” stocks saw their prices rise by more than 75 percent in the recent year, while the other 493 stocks in the S&P 500 index still gained a respectable double-digits.  The dramatic relative performance of the magnificent 7 is sure to draw additional commentary in the coming weeks as analysts review the scope of 2023’s stock market rally.  The Dow Jones Industrial Average rose by 14 percent and set seven new record closes.  The tech-heavy NASDAQ Composite Index surged a remarkable 43 percent.  Earnings forecasts for the upcoming year anticipate profit growth of 11.8 percent for the companies that comprise the S&P 500 Index, according to the FactSet data service.  Rising profits combined with a more accommodative Federal Reserve are encouraging indications that the capital markets can produce another productive year for investors.

There are plenty of stories in the news to support either an optimistic or pessimistic view, which makes it extraordinarily difficult to forecast the capital markets.  Stock and bond prices reflect valuations, not values.  While our values may be offended by world events, valuations can still rise due to the economic opportunity ahead of us.  The next provocative headline could upset, entertain, scare, excite or simply inform us.  Capital markets are only focused on the money.  It is up to us to live worthwhile lives and create the kind of community we find meaningful.  

We always welcome your thoughts, so please contact us at any time.  Our very best wishes to you and your family for a healthy, happy and productive new year.