Providing substance to the thesis that many investment prognosticators would rather be right than rich, the financial press’s take on 2023 was surprisingly curmudgeonly. The Wall Street Journal, in its December 30 edition, headlined “What Did Wall Street Get Right About Markets This Year? Not Much”. Barrons, in its January 1st edition, bemoaned the S&P 500’s inability to close at an all-time high headlining “The Stock Market Saved Its Biggest Disappointment for the Last Day of the Year” taking a rather grinch like view of the indices 24.2% return for the year while reminding readers that 2023 was the first year since 2012 that the index had failed to make at least one record high during the year.
Stock market investors new best friend, Federal Reserve Chairman Jay Powell, was having none of the punditry’s proclivity towards negativity as he offered the promise of what every investor had at the top of their shopping list, lower interest rates! At the chairman’s press conference on December 13th, he spoke words that got stocks hot ‘round the world “if the economy evolves as projected, the …appropriate level of the federal funds rate will be 4.6% at the end of 2024…” There! He said it! Rate reductions of ¾ of a percent next year! From the moment those words left the chairman’s mouth at 2 pm that day to the market close two hours later the Russell 2000, an index of small US companies, rose 4%.
Could it be that markets are starting to “sniff out” something missed by almost all of those ophthalmologically challenged market commentators? A perusal of the data the Fed releases at the conclusion of its meetings reveals that the Fed expects US economic growth to decline from 2.6% in 2023 to next year’s 1.4%, a near 50% deceleration of expected growth in the economy and materially below the 2% rate widely considered “normal”. Those numbers also reveal the Fed expects inflation levels to decline further next year to 2.4%, very close to the Fed’s inflation target. Economists dispute the exact level of interest rate which neither contributes to nor detracts from economic growth rates, but opinions tend to gravitate towards ½% above the rate of inflation. Simple arithmetic is the 2.4% expected rate of inflation + ½% neutral rate of interest equals 2.9%, versus the current Fed Funds rate of 5.5%, offers the prospect of 2.6% possible rate reductions next year. This may be the true source of the sweet aroma wafting upwards past the nostrils of stock market bulls. It may also be that the truly contrarian call for 2024 is for investors to ask themselves “as bullish as you are, are you bullish enough?”.
As we prepare to cast this fed rate tightening cycle into history let’s take a look at an explanation for it resting on the possible existence of ulterior motives, while acknowledging the reality of the near to total misalignment of its cited cause and actual effect. We’re not cynics but are fond of the phrase “cui bono” (who benefits). If the objective that exceeds all others in order of importance is the maintenance of the solvency of the United States government, and if the key measure of that solvency is the outstanding market value of US Federal debt in relation to the nominal (non-inflation adjusted) value of the US economy, then perhaps we have a useful starting point. In the ten years ending 2019 US nominal GDP grew at a 4.1% annual rate. In the three years from Q3 2020 through Q3 2023, due to the higher rate of inflation, that rate rose to 6.3%. With the rise of interest rates the market value of previously issued Federal debt declined in value. On January 1, 2022, the outstanding market value of US Treasury debt was $23.4 trillion. From January 1, 2022, through November 30, 2023, the US Treasury issued $3.9 trillion of additional debt but as of November 30, 2023, the market value of that debt had risen by “only” $765 billion meaning that 80% of the value of the “new” debt was offset by the losses experienced by the holders of the “old” debt. Whether this confluence of circumstances was coincidental or not, it did allow the United States Treasury to issue trillions of dollars of new debt while achieving the remarkable outcome of the outstanding balance of US Treasury debt remaining stable as a share of US GDP from 2019 through Q3 2023. Cui bono? S&P Dow Jones Indices, in their recapitulation of the 2023 market, remained focused on the Magnificent Seven stocks, AI and info tech but that is starting to acquire the feel of yesterday’s story as small cap stocks 12.8% returns for December notably outperformed the 4.5% return of the 500, value outperformed growth, real estate’s 8.7% exceeding info tech’s 3.8% and even foreign developed markets 6% outperforming. The fixed income tortoise finally caught up with the equity hare as 60/40 portfolios returned 13.8% for the year with the equity share returning 22.35% for the year and fixed income eking out a miserly 1% but the tortoise did awaken returning 6.875% versus equities 11.5% for the quarter and 4.875% versus equities 5.50% for the month with the portfolio providing overall returns of 8.75% for the quarter and 5.25% for the month. 60/40 portfolio investors longing for the day when they recapture the remainder of their 2022 losses may not have to wait very much longer as they are now but a modest 4 ½% away.
December 30, 2023/Mark H. Tekamp
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