Highlights:
- November saw the year's best stock and bond returns, with the S&P 500 advancing 9.1% and the Bloomberg U.S. Aggregate Bond Index gaining 4.5%.
- The broad market performance during the November stock rally was notable, marking a departure from the dominance of large technology firms throughout the year.
- Signs of a slowing economy, indicating the impact of Fed actions, included a decline in new jobs, a rise in unemployment claims, and key manufacturing data.
After three dreary months of investment results, November produced the best stock and bond returns of the year. The S&P 500 Index returned 9.1%, pushing the year-to-date to 20.8%, while a sharp decrease in intermediate and long-term yields propelled a 4.5% gain in the Bloomberg U.S. Aggregate Bond Index. The result was a nice boost in portfolio values as we enter the holiday spending season.
While such a sharp shift in investment fortunes might suggest some tectonic economic movement, the causes were much more subtle. For much of the year, the Federal Reserve has been carefully cultivating a skepticism regarding the anti-inflation efficacy of its steep rate increases, including the possibility of an additional quarter-point rise in the fourth quarter. Promoting a shift in this thinking were some promising inflation data prints along with some bad-news-is-good-news signs of economic slowdowns. This, combined with a softening of Fed rhetoric, was enough to reset investor expectations, including chances of a late-year rate increase. Signs of a slowing economy, which suggested that Fed action was producing results, included a downward trend in new jobs and an uptick in unemployment claims. Key manufacturing data added to the sense that Fed action was producing results.
One of the most notable aspects of the November stock rally was its breadth. For much of 2023, index returns have been driven by the outsized returns of seven highly valued large technology firms. November saw strong returns from the equal-weighted S&P 500 and smaller and international stocks.
All of this raises the question: can the prospect of lower Fed rates in 2024 offset the downward trend of the economy in terms of expected stock returns? The current 12-14% 2024 earnings growth expectations for the S&P 500 strike us as highly optimistic. Corporate profits have been basically flat in 2023 at a time when the consumer has remained relatively strong -- can profits really take off in 2024 with signs of a weakening consumer? We continue to be wary of the lag effects of the Fed's rate increases, a growing factor as low-rate financing expires and businesses have to refinance at rates that may be double or more. While strong consumer spending has been a foundation of economic strength over the past two years, the level of consumer loan defaults, the expansion of credit card debt, and the increased availability and popularity of borrowing to buy suggest caution ahead.
In short, we are not proponents of letting the welcome results of November expand into excessive exuberance. Bond yields continue to provide the prospect of real returns from fixed income allocations. The broadening of returns we saw this past month is encouraging for the diversified investment portfolios we build and recommend. While we would welcome Federal Reserve rate cuts in 2024, we feel the prospects of our quality companies are not dependent on them. The dramatic returns of November should confirm the value of sticking with an appropriate asset allocation even as we recognize we may not see its equal for some time.