Quarterly Commentary

Market Overview

As we opened 2023, it had been widely forecast that rising interest rates would lead to a recession sometime in the second half of the year. Afterall, inflation was still well above the Fed’s two-percent target and the markets were coming off a year (2022) of significant equity and fixed income declines. The FOMC had raised rates 450 basis points by the end of 2022 and would go on to raise them another 100 basis points by mid-2023. In the end, however, 2023 became a year that investors would never want to forget.

Stocks closed the year on a high note, with the S&P 500 climbing in each of the last nine weeks of the year. The year-end “push across the finish line” was driven by an increased appetite for risk assets. The appetite for these asset classes was based on resilient economic data, a steadily decreasing inflation rate, and the prospect of at least a few cuts to the Fed Funds rate in the first half of the new year. At least through year-end, investors were able to shrug off the regional banking crisis (SVB, Signature Bank) as well as geopolitical conflicts in Ukraine and the Middle East.

Performance

Stocks rallied 11.7% in the fourth quarter, pushing the S&P 500 to a 26.3% gain for the year. In a reversal of 2022, growth stocks outperformed their value counterparts largely based on AI enthusiasm. The Russell 1000 Growth Index rose 42.7% on the year while the Russell 1000 Value Index rose 11.4%. The NASDAQ Composite Index rose 13.8% for the quarter and 44.7% for the year while the Dow Jones Industrial Average rose 13.1% and 16.2%, respectively. In other capitalization markets, the Russell Mid-Cap Index rose 12.8% for the quarter and 17.2% for the year while the Russell 2000 Index gained 14.0% for the quarter and 16.9% for the year. From a sector perspective, Information Technology led with a one-year return of 56.0% followed by Communications (+52.8%) and Consumer Discretionary (+39.6%). The poorest performing sectors for the year included Utilities (-7.2%), Consumer Staples (-0.8%), and Energy (-0.6%).    

S&P 500 Sector Performance (ETF)

International

Foreign equity markets saw fairly solid gains over the quarter as the MSCI EAFE Index climbed 10.5%. For the year, the developed market index rose 18.9%. The MSCI Emerging Markets Index recorded a 7.9% and 9.8% return for the quarter and year, respectively. Despite these numbers, the global markets lagged domestic market performance for both time periods given the strength of the U.S. economy. Interest rates played a big role, particularly when it came to future expectations. While focus had primarily been on continued tightening by Central Banks across the globe, the focus changed during the fourth quarter to potential future cuts in rates. With the change in expectations, investors will begin to focus on profit and growth potential.

Commodities

The year ended on a bearish note for global commodities as the Bloomberg Commodities Index fell 3.1% in December which capped a down quarter (-5.9%) and year (-12.6%). Energy was the hardest hit in the fourth quarter as WTI crude, Brent crude, and natural gas prices all declined. Precious metals were the best performer for the quarter gaining 9.5%. Industrial metals rose 3.5% in December yet the entire sector declined for the quarter by 0.5%. The agriculture and livestock sectors were likewise negative for the quarter, down 2.1% and 11.0%, respectively.   

Crude Oil Prices - WTI

Fixed Income

The traditional fixed income market, which seemed poised for a second challenging year in a row, benefitted from a rally in Treasuries as the 10-year T-Note declined 105 bps across November and December. The Barclays U.S. Aggregate increased 5.5% for the year after posting a fourth quarter gain of 6.8%. The Federal Open Market Committee (FOMC) held steady in December on the target federal funds rate, its third consecutive meeting with no change. Although the FOMC did not rule out future rate increases, most of the comments focused on a path to future monetary easing. The market immediately began to price in up to 150 basis points of rate cuts which is contrary to what the FOMC had projected (75 bps) at the time.

The rally in U.S. Treasuries that began in November and continued through the end of the year was largely driven by the above mentioned FOMC dovishness. This stance, combined with improving inflation data led market participants to shave over 90 basis points off of the 10-year yield in the last two months of the year. Agency residential and commercial mortgage-backed securities also performed well to end the quarter. For the first time since May, the Bloomberg U.S. MBS Index outperformed the credit markets as measured by the Bloomberg U.S. Credit Index. In the U.S. credit market, spreads tightened relative to duration-matched U.S. Treasuries by 19 bps. Longer duration outperformed shorter-duration with industrials being the top performing sector.

Inflation

The significant relief from inflationary pressures played a pivotal role in fostering positive market trends, offering a respite for both the Federal Reserve and the economy. After reaching its pinnacle at 9.1% in June of 2022, the CPI Index underwent an impressive decline, having been reduced by two-thirds. This dramatic reduction firmly solidified disinflation as the prevailing theme defining the landscape of 2023. According to U.S. Labor Department data, the annual inflation rate for the U.S. was 3.1% for the year.

Consumer Price Index – YoY Change

Fourth Quarter Insights

The S&P 500 finished off 2023 with plenty of momentum after re-entering bull market territory in June. The index punctuated the start of the new year with a nine-week winning streak that put it within striking distance of its first new all-time high since December 2021.

Since 1921 through 2023, the average S&P 500 bull market has generated a return of 157% and lasted more than four years, according to Sam Stovall, chief investment strategist of CFRA Research. That pattern suggests the stock market rally could continue for the foreseeable future.

One of the best-performing investment themes of the current bull market has been artificial intelligence technology. Several of the top-performing tech stocks of 2023 were AI technology stocks, including AI chipmaker Nvidia. James Demmert, chief investment officer at Main Street Research, says the AI-fueled bull market could be just getting started. “The market’s recent strength is indicative of a new and very real AI-led bull market and business cycle that could last a decade thanks to the productivity growth and tailwinds from AI,” Demmert says.

“Experienced investors know that this kind of broad-based strength across all sectors and capitalizations is reminiscent of the first year of previous bull markets that has much further to run, with inevitable corrections along the way.”

In its latest long-term economic projections released in December, the Federal Open Market Committee projects core PCE inflation of 2.4% and GDP growth of 1.4% in 2024. FOMC members also anticipate just three interest rate cuts by the end of 2024.

Higher interest rates increase borrowing costs for consumers and businesses, weighing on economic growth and eating into profits. Investors and analysts generally see rate cuts as bullish for stock prices as long as the cuts are not accompanied by an economic recession.

Fed officials have downplayed the possibility of an imminent rate cut. But many investors remain optimistic that the FOMC will cut rates soon in 2024 and more aggressively than anticipated. The bond market is pricing in a 70% chance the Fed will issue its first interest rate cut by March, according to CME Group.

The market sees a greater than 80% chance of at least five rate cuts from current levels by the end of 2024.

Investor optimism about the economic outlook has improved dramatically from a year ago, but there’s still a risk that Fed policy tightening could tip the economy into a recession in 2024. In fact, the New York Fed’s recession probability model estimates there is still a 62.9% chance of a U.S. recession within the next 12 months.

Brian T. Moore

February 2024

References

1. S&P 500 Sector Return Data
   Morningstar:  Third Quarter 2023 total return of ETF proxies.
2. Crude Oil Prices – WTI - 
   Federal Reserve Economic Data:  Year to date, crude oil prices, West Texas Intermediate.
3. CPI – Year over Year Change -
   Federal Reserve Economic Data: Year over year percentage change September 2023.

Disclaimer
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Chesapeake Wealth Management), or any non-investment related content, made reference to directly or indirectly in this newsletter, will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from Chesapeake Wealth Management. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his or her individual situation, he or she is encouraged to consult with the professional advisor of his or her choosing. Chesapeake Wealth Management is neither a law firm nor a Certified Public Accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the Chesapeake Financial Group, Inc.’s current written disclosure statement discussing our advisory services and fees is available upon request.