WESCAP Q4 Quarterly Commentary: Strong Stock Market Returns and Interest Rate Cuts
Portfolio results for the last quarter of 2023 were generally and strongly positive across stocks, bonds, real estate, and most other assets. Strong 2023 gains in U.S. and global stock market indices reduced or in some cases eliminated the large losses experienced in 2022.
Lower inflation in the latter part of 2023 resulted in the U.S. Federal Reserve (Fed) pausing its prior policy of serial increases in short-term interest rates. This also triggered a decline in long-term interest rates, which boosted bond prices and reduced financial stress for many borrowers.
The U.S. Core Consumer Price Index (CPI) increased by less than 2% annualized for the prior 3 and 6 months through November, respectively, when excluding the “shelter” component of the CPI. The shelter (residential rents) component can have a 6 to 12 month lag within the CPI, which tends to distort contemporaneous inflation indicators. As the Fed also uses this ex-shelter Core CPI in its decision making, it tends to set the tone for the Fed’s future actions. Given that this measure of inflation is trending under the 2% inflation target that the Fed has set, it gives a good reason for the Federal Reserve to cut interest rates in 2024, assuming inflation continues to behave well.
Future interest rate cuts also reduce the chance of a 2024 recession. Historically, the Fed’s prior actions of increasing short-term interest by as much as it has (5.25%) would normally result in a recession. However, the Covid-induced shortages of materials, housing inventory, and labor have created more robust economic conditions now than in prior business cycles (i.e., more resistance to interest rate hikes). Consequently, it is quite possible that the economy can continue its growth trend and avoid recession, despite the current high level of short-term interest rates.
Even if a recession does develop, it is expected to be mild and short-lived as underlying business and household finances appear to be much stronger than in 2008 and most other time periods. The potential for a mild 2024 recession is somewhat immaterial if we are looking out beyond 24 months. Any asset price declines over the next 3 to 9 months may very well be good buying opportunities, much as 2022 recession fears induced price declines set the stage for very robust 2023 asset returns.
Higher short-term interest rates allow an investor to now receive a reasonable rate of return by owning money market funds, T-bills, and other short duration, low-risk, fixed-income assets. Assuming the Fed cuts short-term interest rates later this year, these investments will begin to lose some of their current attraction. Therefore, a pivot into longer maturity fixed income assets in 2024 is likely warranted.
Due to the possibility of slower economic growth in 2024 plus growing geo-political risks, we continue to focus on undervalued and defensive asset classes and strategies.
We will discuss some of these topics in greater detail in our upcoming 2024 Economic and Investment Outlook.
If you would like to discuss this further, please feel free to contact WESCAP.