Update on the Markets:

Index	4th Quarter 2023	Full Year 2023
S & P 500 (Large US Stocks)	11.69%	26.29%
Russell 2000 (Small US Stocks)	14.03%	16.93%
FTSE All-World ex-US (International Stocks)	9.76%	16.20%
Barclays US Aggregate (Bonds)	6.82%	5.53%

January 2024

Key takeaways

► Market goes gangbusters

► It’s Goldilocks for now

► Recession still possible

► Smaller stocks getting some love

► Ride the front-end of the curve

What an exceptional year!

The end of the year saw a boom in stocks and bonds, surprising everyone. Euphoria about falling inflation + a solid labor market drove stock indexes to record highs. On December 13, the Fed even signaled it may cut rates three times in 2024. As investors reckoned that the Fed shifted from fighting inflation to avoiding a recession, everything went up.

2023 US Stock Market Performance

It didn’t start that way. At the beginning of 2023, professional investors saw stubbornly high inflation, a Fed relentlessly raising interest rates, a near-certain global recession, a tired consumer, and a war in Ukraine.

Things turned out differently – Goldilocks different: Not too hot. Not too cold. Inflation cooled significantly without a recession. The labor market remained resilient. Oil did not spike. It ended the year pretty much where it started. And stocks rallied hard. Bonds rallied hard. 2023 was the year for tech, especially anything Alternative Intelligence (AI). Tech darling Nvidia (NVDA) finished the year up 237%. The “Magnificent 7” (Microsoft, Amazon, Meta, Apple, Alphabet, Nvidia, and Tesla) collectively rose 111%. Nasdaq jumped 45%. The S&P 500 rose 26%. Russell 2000 gained 17%.

The yield on the 10-year US Treasury dropped from an intraday high of 5.02% on October 23 to finish the year at 3.88%.

Hard landing, soft landing, no landing???

A soft landing occurs when a recession does not follow a series of rate hikes – a tightening of monetary policy. Economists disagree about how many soft landings the US economy experienced since World War II, but most agree that 1994-95 was undoubtedly one of them. Back then, The US avoided a recession despite a hike in fed funds from January 1994’s 3.0% to 6.0% in February 1995 through June 1995. A hard landing is the opposite, and it is what occurs typically after the Fed tightens. Soft landings are rare indeed. Right now, the soft-landing camp is winning.

The Fed probably finished raising rates. However, its effects are still making their way through the economy. A recession is still possible, especially if there is a global shock. At the Fed, it may no longer be “higher for longer” regarding interest rates, but market predictions of as many as 6-7 cuts seem highly improbable. And if the Fed sees the need to cut so much, well, we have bigger problems as it is probably due to a hard landing: the economy slows, unemployment jumps, corporate profits drop, and down go stocks.

The labor market is slowing but still very solid. Wage growth continues to outpace inflation. Will wage growth lead to a spike in inflation?

US Salaries and Wages Growth

In addition, as discussed last quarter, the ever-increasing federal deficit may pressure rates as overwhelming treasury supply hits the market.

Other factors point to a moderation in economic activity. Have consumers finally spent their Covid savings??? If you’re like me, you’re tired of hearing about “Covid savings.” Economic growth may be curtailed by less bank lending due to higher rates, an inverted yield curve, more capital controls, underwater bond investments, and soured commercial real estate loans. And there is always the usual geopolitical stuff: Ukraine, the Middle East, Taiwan.

A broadening market

Stocks should broaden out from Magnificent 7. The AI tsunami may wash over the rest of the market, though the leaders will probably stay the leaders. They are so expensive…and so good. One concern is how much of 2024 performance was pulled into 2023. Investors may be carried away when futures markets predict 6-7 rate cuts this year.

And small-cap stocks may join the party. They are relatively attractive, especially if you do not think a recession is imminent. The forward Price/Earnings ratio (P/E) on small caps is 15X while on the S & P 500, it is 24X.

What to do?

Large-cap stocks are not cheap. While the S&P 500 may be profitable this year, prepare for muted gains in the future. Prepare for volatility: government shutdowns, geopolitical crises, and sunset of the 2017 Tax Cuts and Jobs Act. And remember the Presidential elections, in addition to the US, India is one of the most significant. We may see plenty of disinformation driven by AI. Political risks are exceptionally high in the US. Can Congress avoid a government shutdown? Will we see a contested Presidential election? Does a third-party candidate act as a spoiler?

But there is a lot of money sitting in cash! If money market yields fall, that money will have to find a new home, probably stocks.In stocks, stick with quality. Stock-picking will be critical as the S&P 500 index is dominated by the Magnificent 7. Hence, I am reducing exposure to index funds. Add small and mid-caps as they’re cheaper and may participate in a broadening market. Maintain a healthy exposure to bonds, especially high-quality short/intermediate sectors. It is hard to give up 5.25% in money market funds with all that is happening. And it is easy to earn 7.00% without significantly degrading quality. As stock performance may be less robust going forward, I am looking for short-term, high-quality, income-producing investments that yield a healthy return. Think commercial mortgages, residential mortgages, student loans, and asset-backed securities.

Broad diversification across asset classes remains vital to success. Only make small tilts. The market is unpredictable. And you never want to be entirely out of it, either. Economic, political, and, especially, your circumstances indicate how much you should have in stocks. But the trend is clear.

Let’s discuss your appropriate split between stocks, bonds, and alternatives.

So many of you have asked me: What are you reading? I’ll post a book recommendation in every quarterly letter. This month’s recommendation comes from Adam Grant, a professor at the Wharton School:

Life After Power: Seven Presidents and Their Search for Purpose Beyond the White House

Many of you are retired and may be searching for meaning now that your previous identity and routine are gone. “Life After Power” tells the stories of seven former presidents, from Thomas Jefferson to George W. Bush. Reading about how they moved on from the highest office may give you insight into how you can do the same.

Please let me know if you have any questions or concerns. All the best in 2024!

Sincerely, 
Henry 

Henry Gorecki, CFP® 
HG Wealth Management LLC 
401 N Michigan Ave, Suite 1200
Chicago, IL  60611
312-723-5116