Santa Claus Rally 2023
In a week where there was more evidence that inflation is slowing and the Fed is gearing up to start cutting interest rates, Santa Claus fired up his sled and sprinkled some holiday magic on financial markets. The action was a relief for investors, many of whom are still feeling the sting of 2022, a year when the S&P 500 fell 19.4 percent and the tech-heavy NASDAQ tumbled by 33.1 percent, led lower by big tech names. Last year was doubly painful because bonds did not provide ballast against the poor performance of stocks, in 2022, the S&P aggregate bond index was down 12 percent.
With two weeks to go before we close out 2023, stocks have come charging back: the Dow Jones industrial average closing above 37,000 and reaching a new all-time high; the S&P 500 rising to within 1.6 percent of its all-time high, reached on January 3, 2022, and is up more than 22 percent on the year, and the Nasdaq Composite, the biggest loser of 2022, charging ahead by more than 40 percent on the year.
Bond investors have endured a wild ride in 2023: just a few months ago, bond prices were in negative territory, but over the past month, yields have come down and prices are higher, putting investors on track to for a positive return of more than 4.5 percent on the year, as measured by the S&P U.S. Aggregate Bond Index.
In thinking about the last two years, there are some specific lessons that are helpful in thinking about what might come next.
Don’t Try to Predict the Future: A year ago, there was an almost universal belief that 2023 would usher in a recession. Economists, analysts, and your cousin were all convinced that the Fed’s rate hikes, combined with inflation, would put an end to the economic expansion that started after the brief, but deep COVID recession of 2020. As it turns out, the U.S. economy turned in solid growth in the first half of the year of more than 2 percent annualized, then soared at an annualized pace of 5.2 percent in Q3, and is likely to finish Q4 with more than a 2 percent annualized pace.
Credit goes to consumers, who continue to propel growth with excess pandemic savings and with the security of a solid labor market. The economy has added an average of about 230,000 jobs per month through November, though job creation is tapering off more recently, and the unemployment rate stands at 3.7 percent.
The Inflation Fever Has Broken, but High Prices Still Persist: The annual inflation rate (as measured by the Consumer Price Index) peaked in June 2022 at 9.1 percent, a four-decade high. As of November, the annual rate of inflation now stands at 3.1 percent and the core rate, which strips out volatile food and energy, is up 4 percent from a year ago. While inflation is moving in the right direction, you’re not crazy if you feel like everything costs more than before COVID. In fact, today it takes almost $120 to buy what $100 bought in November 2019!
High Rates Are a Double-Edged Sword: The Fed’s rate hike campaign, which was intended to quell inflation, began in March 2022, and likely ended in July 2023. Short term interest rates soared from zero to the current range of 5.25-5.5 percent, which was either good or bad news, depending on your financial situation. Savers have been devouring high interest savings accounts and certificates of deposit, which are now routinely earning 5 percent or more.
But for borrowers, high rates have inflicted a lot of pain. If you carry a credit card balance, you are paying over 21 percent; auto loans for new cars are averaging about 8 percent; and while mortgage rates for 30-year fixed loans have retreated from 22-year highs 7.8 percent in late October, they are now at just under 7 percent, which is more than double the rate seen just two years ago.
Reconsider Buying a House: It’s not just those high mortgage interest rates that are causing would-be homebuyers’ pain. The pandemic surge in housing demand, combined with low levels of inventory, has now distorted the homebuying market, driving prices up by more than 40 percent than prior to the pandemic. Given that housing affordability is tumbling, it’s time to ease up on your quest to buy a home and stay on the sidelines, at least for the foreseeable future. The good news is that rents are finally easing (the median U.S. asking rent declined 2.1 percent year over year in November, according to Redfin) and as a bonus, just think of how much more time you will have when you stop surfing real estate sites!
You STILL Can’t Time the Market, REALLY! After the 2022 wash-out, there were many investors who bailed on their long-term strategies and sought the protection of safe assets, like high yielding savings and money market accounts, CDs and Treasury bills, all of which were finally paying a decent amount of interest. I heard from a lot of those folks, who would regale me with their game plans that went something like, “I got out stocks and bonds and went to cash (I’m getting 5 percent!!!), but I plan to get back in when things get better.” Of course, this is the fallacy of attempting to time the market: those people probably felt great, up until about the summer. Now as we approach the end of the year and markets have regained their footing, many will be forced to buy back into their positions, but at much higher levels.
Picking Individual Stocks Is Hard: A year ago, the technology sector was on its heels. Profits were down, layoffs were up, and investors were trying to figure out the next great sector. And yet, last year’s losers have become this year’s BIG winners. They have been dubbed “The Magnificent Seven” (Apple, Amazon, Alphabet, NVIDIA, Meta, Microsoft, and Tesla) and together, they are up around 70 percent year to date. Of course, if you own the S&P 500 index, you have a piece of the action, but if your expensive fund manager was not a believer in tech’s resurgence, you missed out. Another reason to own low fee and tax efficient index mutual and exchange-traded funds.