The financial markets in 2023 gave us pretty much what we expected. The Fed continued raising rates and then paused at the end of the year. Inflation, while not to the 2% the Fed claims they are targeting, seems to have cooled to a reasonable enough level that they are no longer aggressively attacking it. They have indicated that they expect to lower rates a few times in 2024, which hopefully means we have reached the peak of this interest rate cycle.
Both the stock and the bond market reacted favorably with a wonderful year-end rally. PE ratios have come up from their lows in October of 2023, but are still at reasonable levels. In particular, most of the rally in 2023 was in the stocks that did the worst in 2022. That means that much of the stock market has not yet recovered and has significant room for growth. In the bond market, if interest rates do fall in 2024, we would expect capital appreciation, as well as the interest that the bonds are kicking out. Corporate bonds are still paying close to 5%, whilst high yield bonds are still in the 7% range.
Our hope is that the rally continues until PE ratios are more in line with historical averages. It is very likely in a good recovery that the pendulum swings too far and PE ratios could exceed their historical averages later this year. If we see a continued rally, we will rebalance, and if we see a significant fall, we will buy more stocks.
Historically, election years are good for the market, as more than half of people end up happy. This year’s election does look a bit weirder than usual, but we don’t expect a significant impact to the market in the first half of the year. It is also statistically more likely that the election will impact the market positively in the second half of the year. We do expect this year’s election to be particularly contentious, so keep in mind that the market can ignore many external forces if they don’t affect corporate profits. For example, unless a disaster or a political shift affects the profits of Apple, the stock price should not be affected.
Our focus for 2024 remains the Fed. If they lower rates more slowly or later than expected, that should have a negative impact on the market. If they lower them more quickly or sooner than expected, then we expect the market to grow faster. Just like last year, this is the age-old question of, “Are we there yet?” It was expected in 2023 that the Fed would pause and even lower rates. That didn’t happen. This year, we expect a few rate cuts. That may or may not happen in 2024. The good news is that we believe in the Fed’s competence and the US economy. So for us, it’s not a question of, “if”, but more a question of, “when.”