The last week of 2023 went about as I expected - gentle gains with little volatility. Large-caps, Treasuries & utilities all posted gains and small-caps, even though they produced a modest loss on the week, remain in an undeniable uptrend relative to the S&P 500. Tech and communication services stocks - the two leaders of 2023 - are continuing to underperform the S&P 500 now, giving the leadership mantle over to cyclicals. Those two developments have been good for the market as breadth has improved considerably following the halcyon days of the “magnificent 7”. It creates a better opportunity set for the equity market as a whole if more of it is participating and that’s what we’ve been seeing over the past two months.
Now, that’s the good news, but here are the challenges I think the markets and the economy are still facing heading into 2024. If we look at inflation-adjusted index levels, the Nasdaq 100 and S&P 500 are still 8% and 10% below their all-time highs, respectively. On a real, not nominal, basis, we’re still in the drawdown, which means it’s entirely possible this is still one huge bear market rally. The other big question is how the financial markets handle Fed policy decisions in the new year. Are they running the risk of reigniting inflation by starting a new easing cycle while the core rate is still at 4%? Is the Fed planning on cutting rates despite a 3% annualized GDP growth rate and 4% unemployment because they sense something’s going on (a credit event, a housing correction) and are actually trying to get in front of it? What about the lagged impact of the four rate hikes the central bank completed in 2023?
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