A Year Ends, Does an Era also?
“[W]ithout interest it becomes impossible to value investments.”
The Price of Time, The Real Story of Interest, Edward Chancellor
2023 was another difficult year. After the very painful market downturns in 2022, in 2023 the equity and fixed income markets both experienced material volatility, while new wars and geopolitical shocks rattled the world.
The equity markets began the year strong – by end of July the Dow Jones was up 8.55%, the S&P 500 up 20.65% and the Russell 3000 (representing approximately 96% of the investable U.S. equity market) up 20.33%.
From August through October, however, these markets fell, during this three-month period the Dow declined 6.55%, the S&P 500 8.25% and the Russell 3000 9.08%. In other words, the Dow had given up most of its yearly gains (during October the Dow fell into negative territory) and the S&P 500 and the Russell 3000 gave up almost half of their year-to-date gains.
By the end of October, the financial press was full of depressing headlines, for example the Wall Street Journal reporting on October 27 that “The S&P 500 Falls Into a Correction, Following the Nasdaq Composite.”
These drawdowns in the equity markets occurred as a new war broke out in the middle east, beginning with the slaughter of 1200 Israelis on October 7. As that war began, the Russia-Ukraine war continued in a seemingly bloody stalemate and the hoped-for success of a Ukrainian counter-offensive failing to materialize.
Returns in the broad fixed income markets were also distressing. In October the yields on ten-year US treasuries raced upward, reaching 5% for the first time since 2007. Bond prices, which move inversely to yields, fell. The Bloomberg US Aggregate Bond Index, a broad-based, market capitalization-weighted bond market index frequently used as a stand-in for measuring the performance of the US bond market, ended October down 2.77% for the year, the Bloomberg US Treasury Total Return Index, which measures debt issued by the US government, was down 2.71%, and the Bloomberg US Corporate Total Return Index, which measures debt issued by US corporations, was down 1.86%.
October ended with new and older geopolitical shocks reverberating around the globe, and after three months of constant market downturns, the environment was unpleasant and accompanied by a feeling that things could easily get worse through year-end.
Instead, markets turned sharply upwards. In November the Dow, S&P 500 and Russell 3000 gained, respectively, 9.15%, 9.13% and 9.32%.
Then, on December 13, the Federal Reserve held its last meeting for the year. Following standard practice, the Chairman of the Fed, Jerome Powell, gave a news conference and, as usual, observers interpreted his comments with the same vigor as the ancient Greeks interpreted the Delphic oracle. Among other comments, Chairman Powell stated that the short-term interest rate controlled by the Fed was “at or near its peak for the tightening cycle” and that interest rate cuts were “coming into view” and “clearly a topic of discussion.” At the same time the Fed released a chart (often referred to as the “dot plot”) indicating that its members anticipated rate cuts in 2024.
This was enough to convince markets that the Fed’s campaign against inflation which had involved a record pace of interest rate increases in 2022 and into 2023, was over, and that interest rates in 2024 would decline. The Dow that week reached all-time highs and the S&P 500 was up 2.5%, its seventh consecutive week of gains.
By December 31, full year total returns were in, with the Dow, S&P 500 and Russell 3000 up, respectively, 16.18%, 26.29%, and 25.96%. The S&P 500 closed the year with nine consecutive weekly gains, its longest streak since January 2004 (notably, most of the S&P 500 gains are attributable to 7 of the 500 companies that make up the index). On the fixed income side, the world debt market posted one of its biggest two-month gains on record in November and December. The Bloomberg US Aggregate Bond Index ended the year up 5.53%, the US Treasury Total Return Index up 4.05% and the US Corporate Total Return up 8.52%.
This was much needed good news, after what has seemed like an eternity of bad news, beginning with the onset of the covid pandemic in February/March 2020, continuing with shut-down and stay at home orders, then weeks of civil unrest in American cities, a disputed election and interference with the orderly transition of power, and then troubling upheavals in Afghanistan, Ukraine and the Middle East, not to mention an inflation surge that crushed market returns in 2022.
Where does all of this lead us heading in 2024 – perhaps with at least two fundamental questions: (1) is the era of ultra-low interest rates over and (2) will the economy continue to avoid a recession notwithstanding the dramatic rise in interest rates over the past two years?
As to the first question, it is common to think of historical eras in terms of the economic conditions that prevailed for long periods of time – the “roaring twenties” for the post WWI period, the Great Depression for the years 1929-1941, the post-war boom for the period 1950-1973, etc. Some market observers are now considering the period after the 2008 great financial crisis to be the “era of free money” because of the various dramatic actions of the Federal Reserve which drove down the price of interest to record lows, thereby harming creditors who were unable to earn reasonable interest on loans, benefitting debtors who could borrow vast sums cheaply, while, possibly, causing distortions in the financial markets that still exist and need to be unwound.
Unfortunately, predicting the future direction of interest rates is notoriously difficult, and while it is reasonable to assume that the Federal Reserve would be loath, after its painful campaign of the last two years, to again drive down interest rates to a “zero bound” level or into “negative real rate” territory, should some new unforeseen event push the economy towards a recessionary cliff, it could well do so. However, at least for now, while the latest projections of the Fed do anticipate interest rate cuts in 2024, those cuts would still leave the Fed’s key benchmark borrowing rate at levels last seen in 2007. Because historically interest rates have been above the rate of inflation, the return to this historical norm is, according to the chief economist of Vanguard, Joe Davis, the “single best financial market development over the past two decades.”
As to whether a recession will occur in 2024, economists disagree. One camp argues that the full effect of the recent large interest rate increases is still unfolding and that the ongoing trauma in the commercial real estate market could cause a crisis amongst regional banks (one headline said “Hold the Champagne on the economy”). Others agree with the Goldman Sachs Research group which argues that “The Hard Part Is Over” and that they “see only limited recession risk” in 2024.
The events of 2024 will soon provide the answer to this question. It is not hyperbole to say that the results of the November Presidential election will be substantially impacted by whether a recession occurs in the next ten months.
For the moment, let’s be thankful for the market turnaround in 2023 and leave for another day the understandable nervousness over what 2024 might bring.