After losses from equity and fixed-income markets in 2022, 2023 was a rebound year, with both bond and stock indices posting positive returns—some in the double digits. This despite sticky inflation and rising interest rates. While there is reason to believe we’re not out of the tunnel yet, there is undoubtedly light to see and room for optimism. As we enter 2024, we share our thoughts on market consensus, some areas we see potential, and how we’ve positioned ourselves accordingly.
A return to lower but favorable interest rates.
Against the odds, the Federal Reserve has thus far managed a relatively soft landing, with inflation tapering to more normal levels. To this end, the Fed has indicated that it may begin to lower rates this year to minimize the possibility of a recession. While we don’t believe a recession is entirely off the table, it seems likely to be a shallow economic event, barring any major surprises.
The good news is that falling interest-rate environments are typically a boon for bond prices, which typically have an inverse relationship to interest rates. As borrowing becomes cheaper, demand increases, driving up prices and ultimately leading to higher returns. Because of this, many economists are touting the “bonds are back” theme. Furthermore, 2022 was a historically difficult year for fixed income, as rising rates hurt lenders who had locked in lower rates but were forced to borrow at higher rates. As you may remember, such was the cause of the failure of Silicon Valley Bank and several other small and mid-size banks caught in the rising rate environment. As rates stabilize and yields rise, we should see bonds increase in attractiveness.
One important caveat: while the Fed has indicated it will lower rates, we likely won’t see rates fall close to the near-zero levels enjoyed before the pandemic. Gone are the days when historically lower mortgage rates made refinancing an appealing option for homeowners. While real estate has surged in many areas in recent years, there are indicators that some markets have become over-priced, while others remain propped up mainly because the demand for homes continues to outpace supply (this is particularly true in Southern California). We may see prices stabilize in some rate-dependent markets as rates level off.
Cash is finally earning something, but buyers be wary.
In recent months, investors have flocked to money market opportunities, where cash and equivalent investments yield anywhere from 4 to 5%. This starkly contrasts with recent years, when cash returned next to nothing. However, while cash may be earning more, investors should still be wary of leaning too heavily into cash when other market areas can yield double digits. Particularly for those in the accumulation stage, being opportunistic and benefiting from compound returns over time means continuing to explore the benefits of diversification and not getting too attached to large cash positions.
Bonds are primed for a comeback, but equities show opportunity as well.
While bond markets offer a lot of potential, there’s also reason to believe equities have room to run. Although a possible recession could compress discretionary spending amongst consumers, developments in Artificial Intelligence (AI) will likely remain a bright spot and not just for tech companies. Economic growth is traditionally attributed to two factors—population growth and productivity growth. Even though many developed countries are experiencing demographic declines as families have fewer children, AI looks to be a promising source of increased productivity for various industries. These technological enhancements can potentially increase cash flows for companies struggling with a lower labor supply or seeking efficiency improvements. To that end, there is reason to believe that equities could be poised for additional growth despite fairly valued prices, as suggested by historical PE ratios.
While the last few years have been incredibly volatile as markets have worked through a global pandemic, Russia invading Ukraine, record inflation, unease in the Middle East, and more, there is reason to believe there is light at the end of the tunnel. How long the tunnel is and how bright the light remains to be seen, but we find ourselves cautiously optimistic as we face 2024. In light of these themes, we see opportunity in the fixed-income allocation of our portfolios and the bond overlays present in several of our equity funds. These investments offer competitive yields in the current rate environment while dampening our overall risk. At the same time, we continue to explore the equity landscape, seeking the right balance between our long-term belief in an efficient market and a belief in sound corporate fundamentals as a source of stability.
In addition to remaining diligent in the face of a changing investment landscape, we continue apprising ourselves of the latest relevant tax and planning law updates. Doing so enables us to maximize areas of greater certainty as a complement to the uncertainty of financial markets. If we’ve learned anything from the past few years, it’s that the unexpected is highly probable, and a sound financial plan is one of the best tools we can employ in the face of the unknown. As always, we invite you to reach out with any questions regarding your investments or your financial situation. We’re always happy to share more of our thinking. You can also learn more about our current views by checking out our Economic Outlook 2024 video, where we engage in an informal conversation regarding what we’re seeing in the markets.
Matt and Hannah
Disclosures: This information should not be construed as investment, tax, or legal advice. All statements and opinions expressed herein are based upon information considered reliable at the time of publication and are subject to change without notice.