The Year of the Rabbit
2023 Year in Review
By Howard Pressman, CFP®
Greetings and happy New Year. I hope you had a wonderful and joyous holiday season. According to the Chinese zodiac 2023 was the Year of the Rabbit. This was supposed to be a year of gentleness and serenity, beginning with rest and truce. As we reflect on the events of the past year, I think we can all agree that 2023 was anything but gentle and restful. Perhaps the Year of the Rabbit is better reflected in the old parable of the tortoise and the hare. More on that later, but let’s first talk about the economic and market events of this past year.
As the calendar rolled over, many economists were predicting we would enter a recession. The consistent drumbeat of negativity coming from the usually jovial and upbeat world of economists (just kidding) didn’t seem to rain on the consumer’s parade. To be clear, the data supported the recession story. In the face of historic rate increases by our Federal Reserve Bank, most facets of the economy were slowing. What economists failed to account for was us – and boy did we spend, Baby, spend. Perhaps influenced by our experiences during the pandemic, and certainly affected by higher prices and buoyed by a
surprisingly strong labor market, the consumer remained engaged. That engagement was a significant factor in keeping the U.S. economy out of what may have been the most anticipated recession in recent memory. To keep up with the Joneses and with rising prices, many consumers increasingly turned to debt to fuel their purchases, pushing outstanding credit close to pre-pandemic levels. If I had to sum up 2023 in just one word, it would definitely be: resilient.
Speaking of the Federal Reserve Bank, as the year began the Fed continued their efforts to slow the economy by raising short-term interest rates by another 1%. After peaking at 9.1% in July 2022, inflation edged lower and finished 2022 at 6.5%. As inflation continued to cool, the Fed recognized the progress and paused their rate-hiking campaign in July. Towards year end, the Fed seemed to hint that they were done with rate increases. In November, inflation fell even further to 3.1%, providing a nice catalyst to welcome a Santa Rally in stocks.
In March, as temperatures began to rise, Silicon Valley Bank rapidly collapsed, sending a deep freeze through the economy. On March 8th the bank – the 16th largest in the US and focused on financing in the volatile tech start-up space – announced it was taking a $1.8 billion loss on selling U.S. Treasury Notes, to meet customer withdrawals. As you can imagine, this news did not inspire confidence, as many depositors had balances far above FDIC guarantees. Customers began running for the doors, forcing California regulators to shutter the bank a mere two days later. Fearing a much broader contagion and bank run, federal authorities announced they would guarantee all SVB deposits. This kicked off a historic year in bank collapses including First Republic Bank, the second largest bank failure in history, SVB as the third largest, and New York’s Signature Bank as the fourth.
The theme of resilience is best represented by the strength in our labor markets. In March 2022 there were approximately two job openings for every worker. This placed tremendous upward pressure on wages, with hiring employers forced to pay more to lure employees away from their current employers. As 2023 progressed, job openings steadily fell, finishing the year at 1.4 openings for every worker. This was welcome news to inflation hawks, as wages are a significant contributor to the prices consumers pay for goods and services. The best news is that, while job openings declined, employers held on to their current employees, with the current unemployment rate of 3.7% near 50-year lows.
The S&P 500, as you know, is an index of the stock prices of 500 large U.S. companies. In 2023 the S&P rewarded investors with a whopping 26% return. This was a very welcome rally after the almost 19% decline the index posted in 2022. The year started strong for the major stock indexes, with the S&P gaining 19% through the end of July. While temps soared in August, the S&P cooled off dramatically, dropping by more than 10% and officially entering correction territory. The trend reversed in early November as the aforementioned good news on the inflation front, more dovish comments from the Fed, and probably a lot of eggnog ushered in the Santa Rally in stock prices, with the S&P gaining 16% through December 29th.
On the surface, this all looks great. But like many things, peeling back the layers can tell a more nuanced story. A 26% increase in the S&P often implies the economy is on solid footing and U.S. companies are doing well. A deeper look reveals that much of last year’s return was provided by just 7 companies. Dubbed the Magnificent 7, Alphabet (Google), Amazon, Apple, Meta (Facebook), Microsoft, Nvidia, and Tesla did exceptionally well, and the rest was just sort of ‘meh’. As of November, the S&P was up 26%. But, the Magnificent 7 (not to be confused with Steve McQueen, Charles Bronson, and friends) accounted for 16% of that return, meaning the other 493 companies contributed only 10% of the market’s gains. In our opinion, this lack of market breadth is not an indicator of a healthy market. Encouragingly, the late year rally was more broadly based. The same analysis at the end of September revealed that the 493 also-rans accounted for only 2% of the index’s gains. Despite the strong 2023 rally in large tech, the Russell 1000 Growth index, which tracks these companies, remains below its November 2021 peak.
Corporate earnings were flat in 2023, while stock prices grew. This divergence means that stocks are more expensive. A stock’s valuation can be defined as how much an investor is paying for each dollar of earnings generated by the company. Simply put, it’s earnings divided by the stock’s price. The 30-year average for S&P 500 valuation is $16.59, which means investors are willing to pay $16.59 for each $1.00 earned by the S&P. As of December 31, the S&P valuation is $19.51. This is far below the recent highs of 2020, but is still a bit stretched. If we are to see a sustainable and healthy rally in the market, we will need earnings to grow and more than just a handful of companies participating.
As we conclude our reflection on the Year of the Rabbit, peace and gentleness has eluded us yet again. But the markets were very much like the tortoise and the hare. For the fifth year out of the last ten, large U.S. growth companies were the top performers, more than doubling the performance of the next best performing asset class. With valuations stretched 40% above their 20-year average, one should be asking how much longer this can go on.
It’s as if our overconfident hare found performance-enhancing drugs. Betting on the hare may continue to pay off, but the risks are high and getting higher. Ignoring valuations can have a way of biting you. From our perspective, the wiser path continues to be staying broadly diversified. Never make a killing, but never get killed.
As always, we are grateful for your continued trust and confidence and wish you health, happiness and fun in 2024, the Year of the Dragon.