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January 2024 Outlook

By January 26, 2024No Comments

January has been an up-and-down month after pleasantly strong investment returns across most assets in November-December 2023.  The return of the “Magnificent Seven” was widely reported in business news.  For most of 2023, seven giant companies drove the return of the entire S&P 500 index.  At the end of October, they were collectively responsible for the S&P 500 positive year-to-date return of over 11%, while the collective return on the remaining 492 stocks was negative.  These seven companies represent approximately 30% of the S&P 500 index.  The last two months of 2023 finally saw a broader rally in stocks and bonds.  The returns of the seven stocks were so strong that it led to a feeling of missing out, particularly when returns of a “broad” index are a benchmark.  The fact is most of the seven stocks had a very bad 2022, worse than the index, and much of the return was a recovery from that sell-off.  We include the following chart to provide some perspective.

When you look at the chart, those 2023 returns still look impressive, but you have to consider the mathematics of recovery.  If you lose 50% on an investment, you need a 100% return to break even.  Those seven stocks hit a high point in 2021.  By the end of 2023, four of the seven company stocks were still selling for a lower price than their previous high in 2021.  Part of our strategy is to minimize the probability you will experience a significant loss.  There is no guarantee a recovery will be rapid in any given asset class, even a broad index.  For example, it took the NASDAQ over seven years to recover from the 2000-2002 sell-off and about nine years from the 2007-2009 sell-off.

With the general election looming in 2024, there is increased political risk to the markets, which, at the least, may increase volatility.  Global conflicts and continued uncertainty month-to-month about what actions the Federal Reserve may take with respect to interest rates in the U.S. may add to that volatility.  But generally, the economy is relatively strong, and much to the surprise of virtually every economic forecast, we may avoid a recession.  Stocks overall may be well positioned for positive returns in 2024, though we anticipate it may be a bumpy ride along the way.

Unfortunately, even with the recovery in late 2023, the previously “safer” bond investments had not yet fully recovered.  While many bond funds are doing better than the Barclays Aggregate Bond Index, representing the U.S. total investment grade bond market, that index was still over 10% below its previous high in July 2021, even with all dividends reinvested.  While we expect continued recovery in the bond market, what is most remarkable is there have been three years before 2021 when the returns were negative since 1980: 1994 (-2.92%), 1999 (-0.82%), and 2013 (-2.02%).  The magnitude of the 2022 bond market decline (-13.03% total return for AGG) relative to those small losses was historic. It makes sense that it would take longer for the index to fully recover from that unexpectedly large decline.

While returns in technology stocks have more than recovered from the 2022 sell-off, leading to some concern that the sector is at risk of a significant correction, other economic sectors appear attractive on current valuations relative to historical norms and growth prospects.  We highlight a few here:

Insurance

Increasing insurance premiums impact family budgets but can also make investing in insurance companies attractive.  Premium increases lag claims.  We are in a cycle where insurance is being repriced to reflect higher claim costs.  The cycle tends to improve and restore profit margins.  The result is attractive for realizing positive returns.

Aerospace and Defense

It is difficult to imagine a scenario where revenue growth will slow in this sector.  Conflicts around the world, replacing and improving U.S. defense capabilities, and continuing demand for travel are favorable for U.S. manufacturers.  Boeing represents a large part of this sub-sector and will hold down short-term returns while manufacturing flaws are remedied, but the sector remains attractive.

Infrastructure

This category is related to industrials and transportation.  With increased government spending on infrastructure projects and a focus on building U.S. manufacturing capabilities, companies involved in infrastructure look attractive on both current profitability and future growth.  While there is always a risk related to economic growth, this area has strong bipartisan support.

Homebuilders

Declining mortgage rates, significant pent-up demand, and continued migration of baby boomers to southern states are strong trends that should continue to provide homebuilders with revenue and profit growth.

Energy

Energy costs have come down from their highs, also reducing inflation pressure.  Global supply is sufficient to meet demand, including concerns about lower demand from China with below-expected economic growth.  However, a significant, relatively unspoken reason is the increase in U.S. crude production, which is expected to rise to a record 13.2 million barrels per day in 2024 (Energy Information Administration).  The positive effect on energy costs can reduce the attractiveness of energy investments.  However, significant global unrest and conflict can reverse this situation quickly.

Fixed Income

Finally, the last two months of 2023 reversed the historic decline in bond prices correlating to the historically rapid and significant rise in U.S. interest rates engineered by the Federal Reserve Bank.  Yields are up and positive relative to inflation.  The ability to once again generate predictable income should help provide some stability to portfolios in 2024, particularly for those relying on their portfolio for income.  A couple of essential points to keep in mind:

  1. We are in one of the most extended periods of a negative yield curve—short-term rates are still higher than long-term rates. This will reverse.  When the Federal Reserve stops raising rates, particularly if the federal funds rate declines, bonds will perform better than money markets, CDs, and fixed annuities.  The total return for bonds, in general, was strongly positive at the end of 2023.  We expect the trend to continue, albeit more modestly, throughout 2024.  Besides your reserve funds, it is more attractive to consider moving out of cash to lock in higher rates.
  2. Our recommendation to purchase I-Bonds, particularly those who bought the bonds when the rate jumped over 9%, has changed slightly. The I-Bond interest rate is the sum of a fixed rate (currently 1.3% on new bonds purchased by April 30th, 2024) and an inflation rate (currently 3.97%) for a total current rate of 5.27%.  I-Bonds purchased in 2022 had a fixed rate of 0%.  If you bought them, cash them in and buy the new series.  Your current interest rate is only 3.97%.  You will lose three months of interest on bonds held over one year, but you will pick up the 1.3% fixed interest rate versus the 0% of your current I-Bond.  Confusing?  Yes, but call us if you own these bonds and have questions.  They are a reasonably attractive and safe savings alternative if you do not.  You can purchase I-Bonds by visiting treasurydirect.gov and setting up an account.  The limit is $10,000 per person per year.

2023 Taxes

As a final note, Congress may pass tax revisions next week that could modestly impact a few tax returns, mainly around the child tax credit.  You may want to hold off on filing your return.  For those with investment accounts outside of IRAs, Schwab will have the 1099s out by February 16th.  It will be an interesting next two years concerning taxes, and we will provide updates as Congress grapples with what to do about the looming expiration of the Tax Cuts and Jobs Act, passed in 2017 and expiring in 2025.  We expect TCJA to play a big part in the upcoming election.

We appreciate your trust and confidence.  Please feel free to contact us with any questions or concerns.