2023 Market review: A soft landing surfaces (2024)

For much of 2023, the financial markets feared a recession instigated by higher interest rates. And were it not for a technology-led surge in January, U.S. stock markets might have spent much of the first half of 2023 in the red. But the equity markets, like the U.S. economy, proved resilient throughout the year. Impressively, the benchmark S&P 500^® Index only briefly flirted with a negative return at one point in the year at the end of the first quarter, when fears of a banking crisis followed two of the largest bank failures in U.S. history.

The second quarter saw a strong equity rebound as the more sanguine economic backdrop led to better-than-expected corporate earnings, and artificial intelligence burst onto the scene, boosting technology and technology-related companies. When the quarter ended, the NASDAQ Composite Index® had delivered its best first half of a year since 1983, while the S&P 500 Index saw its year-to-date gains rise to nearly 16%.

But the rosier outlook gave way to broad-based gloom in the third quarter as inflation turned higher and benchmark 10-year Treasury bond yields surged to highs not seen in more than 15 years. Real rates—the interest rate paid above the current inflation rate—spiked and mortgage rates lurched to 20-year highs. Interest rate sensitive sectors, such as banking, commercial real estate and the consumer, came under scrutiny. It was beginning to look like the U.S. Federal Reserve (Fed), which didn’t budge from its higher-for-longer mantra in the face of rising inflation, was going to force a recession, instigated by the high interest rates investors had feared all year.

But as the fourth quarter got under way, the clouds parted. Inflation resumed its decline toward the Fed’s target, while economic growth held up and jobs growth looked to be bottoming. Investors began to contemplate the possibility that the Fed—which had raised rates higher and faster than it had in decades—might have steered the economy clear of the once-inevitable hard landing and piloted it to the holy grail of central bank policy: a soft landing. The relief inspired the Bloomberg U.S. Aggregate Bond Index to have one of its best months in nearly 40 years and the S&P 500 Index to rally to a new all-time high.

As we look to 2024, we believe inflation remains the key indicator of Fed policy, and thus the key to the performance of both stock and bond markets. While inflation has retraced about two-thirds of the 2021-2022 surge, November’s U.S. Consumer Price Index (CPI), a common measure of inflation, was still up 3.1% from a year ago. This is a full percentage point above the Fed’s long-term average target, but gas prices have declined, mortgage rates have declined (helping lower the shelter component of CPI) and near-zero good’s price inflation suggests the supply-chain shortages and fading consumer stimulus may have finally found an equilibrium.

Since the post-COVID outbreak of inflation, Fed Chair Jerome Powell has been clear that rate hikes will continue until inflation is under control. While it is too early to declare that victory, 2023 ended on a more positive note, and we are optimistic that 2024 could see further moderation in inflation, and positive returns in both stocks and bonds.

Drilling down

U.S. stocks set new highs

The S&P 500Index rose 24.23% in 2023, setting a new all-time high near year end. Stocks were supported by resilient economic growth, encouraging earnings and expectations that both inflation and interest rates had likely peaked. The total return of the S&P 500 Index (including dividends) was up 26.29% over the period.

The NASDAQ Composite Index was up 43.42% in 2023, supported by strong performance in technology and technology-related companies over the year, fueled in part by expectations that advances in artificial intelligence would boost growth.

Most sectors rose in 2023

Of the S&P 500’s 11 sectors, all but utilities and energy had positive returns in 2023. Information technology led the way, up an impressive 57.84% over the year, followed by technology heavy sectors such as communication services (up 55.80%) and consumer discretionary (up 42.41%). Despite rebounding in the fourth quarter (up 8.56%), the utilities sector was held back by higher interest rates over the period and ended the year down 7.08%. Weakness in the energy sector was largely driven by falling oil prices as global growth slowed.

The chart below shows the results of the 11 sectors for the past month, fourth quarter, and for calendar year 2023.

Retail sales rose

Retail sales in November were up 4.1% from November 2022, according to the Department of Commerce report issued December 14, 2023. For the three-month period from September through November, sales were up 3.4% from the same period a year earlier, while the 11-month total (from January 2023 through November 2023) was up 3.2% from the same period in 2022. This rise in retail sales over the bulk of 2023 was driven by strong gains in food services and drinking establishments (which were up 11.5%), health and personal care store sales (up 8.6%) and non-store retailers (primarily online sales), up 8.3%. Gasoline station sales (down 11.7%) and furnishings and home furniture sales (down 5.5%) were notable detractors over the 11-month period, driven by lower gas prices and rising mortgage costs, respectively.

Job growth slowed

The jobs market slowed over 2023 but may have found a bottom in the second half of the year. The December data, released by the Department of Labor on January 5, 2024, showed that 216,000 new jobs were added during the month—a figure well above consensus expectations—but revealed significant downward revisions in the November and October estimates, resulting in a three-month average of 115,000 new jobs created per month. While 2023 as a whole saw job growth average 225,000 per month—a significant decline from 2022’s average of 399,000 a month—the growth rate has stabilized over the past six months, and thus may have achieved a relatively soft landing.

Average hourly earnings painted a similar picture over the year, ending the year with a 4.1% year-on-year growth rate in December. The figure was up 0.1% from November’s 4.0% growth rate and, despite falling over much of the second half of the year, is still high relative to the optimum level, which is about 3% or a bit higher. While this is above the Fed’s 2.0% long-term average inflation target, higher productivity enables wages to grow above the inflation target.

Treasury yields surged, then retreated

The yield on 10-year U.S. Treasuries soared in 2023, rising from 3.88% at the end of December 2022 to close at a high just shy of 5.0% in October—a level not seen since 2007. But stabilizing inflation and softening growth in the remainder of the fourth quarter prompted investors to anticipate interest rates cuts sooner and more significantly than previously assumed.

The Bloomberg U.S. Aggregate Bond Index, which tracks the performance of U.S. investment-grade bonds, rose 5.53% in 2023, largely due to the current yield offered by the index’s bonds.

Corporate earnings projections keep rising

Corporate 12-month earnings projections for the S&P 500 Index continued to rise, up more than 6% in 2023, from expectations that were lowered in 2022. While rising earnings projections may seem at odds with expectations for a slowing economy, the largest technology and technology-related companies—the so-called “mega cap” stocks like Apple, Alphabet and Amazon—continue to be seen favorably.

Forward P/E ratios rise, earning yields fall

The forward 12-month price-earnings ratio (P/E) of the S&P 500 Index rose in 2023, from 16.65 at the end of December 2022 to 19.51 at the end of December 2023. A higher P/E means stocks are more expensive relative to their earnings per share.

The forward 12-month earnings yield for the S&P 500 Index, which is the inverse of P/E, fell 14.63% over the year. The 12-month forward earnings yield can be helpful in comparing equity earnings yields with current bond yields. The December-end 5.13% equity earnings yield is still well above the 3.88% yield 10-year U.S. Treasuries offered at year end, but the gap continues to narrow.

U.S. dollar falls vs. euro and gains vs. yen

The U.S. dollar depreciated 3.5% versus the euro in 2023, largely on expectations the relatively higher interest rates available in the U.S. could diminish, while appreciating 6.85% versus the Japanese yen as the interest rate differential is expected to remain relatively high given the extremely low level of Japanese bond yields.

Gold reaches a new high

The price of gold rose 13.45% in 2023, reaching a new high as both inflation and geopolitical instability remain elevated, while Treasury bond yields and the U.S. dollar retreated late in the year. A weaker dollar makes the cost of gold, which is priced in dollars, cheaper for foreign buyers, while lower bond yields reduce the opportunity cost of holding commodities like gold, which don’t pay a yield.

Oil prices continue to fall

The price of a barrel of West Texas Intermediate (WTI), a grade of crude oil used as a benchmark in oil pricing, fell 10.73% in 2023, continuing its decline from its peak mid-2022, when it exceeded more than $100 a barrel. At the end of December, a barrel of WTI was priced at $71.65, down more than 25% from the 2022 highs. The decline is largely attributable to slowing global growth and—in recent months—a weaker U.S. dollar.

International equities finish strong

International equities ended 2023 on a strong note, rallying 10.09% in the fourth quarter, boosted by the prospect of lower policy rates in the U.S. and other key regions. The MSCI EAFE Index rose from 1,943.93 at the end of December 2022 to 2,236.16 at the end of December 2023.

Media contact: Callie Briese, 612-844-7340; [email protected]