Markets in December 2023

Markets in December

December continued the end of year rally with the S&P 500 up 4.5%. Leaving it up a staggering 26.3% on the year. Small-cap stocks which have struggled most of the year finally had a big rally with the Russell 2000 surging 12.2%. All eleven sectors were up.
The rally continued as the Federal Reserve kept the fed funds rate at 5.25% - 5.50% for a third consecutive meeting. Keeping the rate unchanged was highly anticipated. However, the markets were pleasantly surprised when the Summary of Economic Projections showed 75 basis points of rate cuts in 2024, compared to the September projections which called for one more rate hike followed by only two cuts next year.
Treasury yields fell further in December with the 10 year moving below 4% after hitting 5% in October.
Inflation tracked by the CPI continued to slow to 3.1% in November, with core inflation coming in at 4%, meeting expectations.
The University of Michigan consumer sentiment index hit its highest reading in five months at 69.7. Most notably is that inflation expectations for the next year dropped from 4.5% to 3.1%.
Consumers spending remained resilient with retail sales increasing 0.3% in November from the previous month.
However, the Leading Economic Indicator slipped 0.5% in December and has been flashing signs of economic stress for 20 consecutive months.

Why it could go higher from here

The primary driver of U.S. economic growth is the U.S consumer and most Americans are fully employed and enjoyed significant wage gains over the past couple years. Most with low debt service costs.
Inflation continues to decelerate, albeit slowly and the Fed has paused hiking rates the past two meetings.
Earnings are rebounding so far in Q3 and analysts forecast additional growth in Q4.
There is a lot of cash is still on the sidelines and investors may put it to work on the fear of missing out.

Biggest Risks

Inflation and the Fed’s response to get it under control are still the biggest risks the economy faces currently. Fed policy impacts the economy with a significant lag so it is hard to determine what the future effects will be from the current rate hikes.
Some research reports indicate that excess savings accumulated during the pandemic may have already been depleted or will be in the near future. Student loan payments also just began again in October.
Credit card debt is reaching an all-time high, delinquency rates are rising on auto loans and credit card balances, and we’re starting to see an increase in bond defaults.
If the economy does begin to slow down, high wage costs may force employers to lay off workers to maintain profit margins.
Additional bank failures and commercial real estate defaults.

Economic Data

Nonfarm payrolls increased by 199k in November, more than the 175k expected. The unemployment rate fell to 3.7% as an estimated 500k people came back into the workforce. Average hourly earnings were slightly higher than expected up 0.4% over the month.

The JOLTS report showed job openings fell to 8.73 million in October. The lowest reading since March 2021.

The US ISM Manufacturing PMI remained in contraction for the 13th consecutive month in November coming in at 46.7.

PPI increased only 0.9% in November over the year, with the core up 2%.

Existing homes sales ended a five month streak of declines as they were up 0.8% in November. Likely due to the fall in mortgage rates, as rates fell below 7%.

The NFIB Small Business Optimism Index dropped to 90.6 in November, the fourth consecutive dip.

What We Are Doing

The economy continues to defy high interest and high nominal GDP supports corporate earnings. The goldilocks data of falling inflation, a resilient consumer, and slightly cooling employment data allowed the Fed to signal that they are likely done raising rates. The conversation has now moved to when they will begin to cut rates. They indicated 75 bps of cuts next year. Yet, the markets are pricing double that amount.

The odds of a soft landing have increased but we are not out of the woods yet. The markets are once again pricing in an idealistic scenario and any deviation from this best case scenario playing out could cause the markets to reprice once again. Overall, we are still maintaining a slightly conservative tilt in our portfolios awaiting further clarity that the cracks that are forming in the economy won’t break.

That said, today’s market is still an attractive entry point to put some cash to work. Even if the economy deteriorates, it will likely be mild and fixed income will once again provide a nice hedge. We will continue to watch the economic dynamic carefully to take advantage of opportunities as they present themselves.