Stock markets ended 2023 on a high note, with the developed markets coming in more than 20% ahead for the year on increasingly optimistic interest rate expectations, further bolstered by a more dovish closing Federal Reserve meeting.
The S&P 500 Index produced a 24% return as the market rally broadened out during a year in which the Magnificent Seven tech and AI stocks had dominated for much of the year. According to Rothschild, the AI highfliers contributed 80% towards index returns last year, but in the previous quarter, 33% of the index reached new 52-week highs. The Russell 200 Index of mid-cap stocks delivered low double-digit returns for the month and year.
Meanwhile, Canada’s S&P/TSX Composite Index ended the year 8% higher but well behind the US stock market, which got most of its performance from these high-tech counters.
The impressive annual returns belie the twists and turns of the stock markets during a year in which the US banking sector experienced a bump in the road, expectations of recession ebbed and waned, and geopolitical turmoil in the Middle East and between Ukraine and Russia loomed large.
Crude oil prices shrugged off tensions in the Middle East and ended the year more than 10% down for the year, despite OPEC’s best efforts to restrict supply with its production cutbacks. Instead, new trade dynamics and lower-than-expected oil demand saw the price of Brent crude averaging $83 a barrel in 2023, $19 a barrel lower than 2022’s average.
Bond investors got caught up in the year-end optimism, with the 10-year US Treasury yield retracing to under 4%, enabling the bond market to end the year in positive territory, retracing the lost ground after yields rose 100-basis points during the year to trade at almost 5% in October.
The Fed kept interest rates at their current levels at its December meeting, keeping interest rates at their current level for the third meeting in a row, having raised them 11 times since early 2022.
Though relatively uneventful, Powell’s monetary policy statement – and reference to avoiding any unnecessary damage to the economy – was a fillip for financial markets, which rallied strongly in the wake of his comments. The Dow Jones Industrial Average rose 1.4%, its highest closing level since the start of 2022. Other benchmark US indices also rose sharply, with the S&P500 up 1.4% and a mere 2% away from its record high. Ten-year US Treasuries were also bolstered by the outcome of the Fed meeting, with yields declining to 4.032% as prices rose.
The Fed’s dot plot now indicates there could be three rate decreases this year against a backdrop of waning inflation and the US November core inflation rate coming in at 3.2% – its lowest level since April 2021. Financial markets are more exuberant, pricing in six cuts, with the first as early as March, raising concerns that markets may be pricing for perfection when several risks could derail this optimistic outlook.
Powell did indicate the central bank was aware of the risk of hanging on too long by maintaining interest rates at current levels and said: “We’re very focused on not making that mistake.” However, he again reminded markets that there are risks and it’s too early to declare victory in bringing inflation back to its 2% target range.
The US economy will benefit from slowing inflation and wage growth but may still feel the after-effects of the steep rate increases. Economists predict a deceleration in US economic growth to below 2% this year from more than 2% in 2023.
Major international stock markets put in varied performances, with European equities being the best performers, boosted by IT stocks. The Eurostoxx 50 Index rose 18.4% during the year, not too far behind the US stock market. The FTSE 100 put in a tepid performance, gaining less than 4% during the year due to the more severe economic slowdown and significantly higher inflation that have posed particular economic challenges in the UK.
China’s weak performance weighed down emerging market financial market performance. As the second largest country in the world, China’s fortunes directly impact emerging markets and the global environment more broadly. Ongoing property woes and the country’s failed attempts to achieve a better-than-expected growth rebound after emerging from the Covid lockdowns saw the CSI 300 Index slump 12.5% during 2023.
Other emerging markets experienced varied performance, with the Bovespa Index up 22.3% and India’s Nifty 50 20% in 2023. Other top global equity performers of 2023 included Sri Lanka and Lebanon, which Jason Xavier, head of EMEA ETF capital markets at Franklin Templeton, described as diamonds in the rough.
Japanese equities delivered a remarkable performance during 2023, advancing almost 30% and reaching their highest levels since 1989. Schroders pinpoints three factors that it believes have driven Japan’s equities higher: confidence regarding corporate earnings, attractive valuations, and the Tokyo Stock Exchange (TSE)’s call in early 2023 for companies to focus on achieving sustainable growth and enhancing corporate value.
It was a challenging year for commercial real estate as sky-high interest rates raised the cost of borrowing, undermining the profitability and, thus, the feasibility of new developments. Rental growth slowed, and vacancy growth rates increased but did vary across sectors.
The office sector was the hardest-hit segment of the commercial property industry in 2023 because it experienced the double-whammy of higher interest rates and inflation and continues to suffer from the impact of Covid on vacancy rates. Though people are returning to work in physical offices, hybrid arrangements continue to predominate, and demand for office space remains lacklustre.
Other sectors that fared better last year, notwithstanding the significant increase in interest rates, were the retail and industrial sectors. According to the National Association of Realtors, the retail property sector did experience slower rent growth but performed better in 2023 than pre-pandemic. It says the absorption of retail spaces increased, and vacancy rates remained at 10-year lows of 4.1%. Meanwhile, in 2023, the industrial sector experienced the best growth, with rental costs increased by almost 7% on a year ago and vacancy rates moderating further.
The Association of Realtors expects it to be another challenging year for the office sector as hybrid workplace policies are expected to become a lasting feature. The retail property sector is expected to maintain its strength. However, performance will likely vary across different retail spaces, with neighbourhood and strip centres experiencing the most robust rental growth.
The industrial sector, mainly warehouse and distribution spaces, should continue to perform well in the face of the rapid growth in retail e-commerce and fewer spaces under construction to satisfy the demand.
Though China’s economic growth is expected to reach its targeted 5% this year, it faces some entrenched structural challenges that mean growth is expected to slow. These include a beleaguered property market, high levels of indebtedness, anemic consumer spending, and an aging population.
The World Bank calls China’s recovery “fragile” and expects its economic growth to slow sharply from 5.2% in 2023 to 4.5% this year and to 4.3% in 2025.
The latest debt and property crisis casualty is Zhongzhi Enterprise Group, a shadow bank that filed for bankruptcy in the first week of January. The government has tried to constrain the rapid growth in non-bank debt by shadow banks, which have funded purchases of local government land.
The protracted property market crisis since 2020 almost brought Evergrande and Country Garden to their knees. The government has actively tried to alleviate the property crisis – a crucial contributor to the Chinese company – but suppliers, creditors, and local government revenue are likely to remain under pressure, and public investment will dwindle further.
Other notable developments during 2023 were the expansion of the BRICS economic bloc, signaling a shift away from the US’s hegemony to a world order that looks set to be bifurcated into a Western bloc and China, Russia, and the so-called Global South, which represents countries in Africa, Latin America, the Caribbean, Asia, and Oceania.
A surprisingly robust US economy, falling inflation, and a prolonged pause in interest rate hikes translated into muted market volatility during 2023. At year-end, the surge in optimism was reflected in a sharp decline in the VIX, the benchmark for market volatility, to its lowest level since 2019. That’s notwithstanding the mini-banking crisis and Israel’s invasion of Gaza, which risks spreading hostilities more broadly in the Middle East.
During 2024, concerns about indebtedness will likely come to the fore, with consumer debt rising to new heights at the end of last year. In the US, the Fed’s latest Consumer Credit report showed consumer borrowing in November was more than double economists’ expectations at $23.75 billion versus an expected $9 billion.
Statistics Canada data showed the household debt service ratio rose to 15.2% in the third quarter – its highest ratio ever recorded – and consumer debt burdens are likely to increase as homeowners renew mortgages at much higher interest rates than in the near-zero era.
Against this mixed outlook for 2024 and a market seemingly priced for perfection, investors must stay informed about the global economy and its many moving parts. We continue to seek out quality companies at reasonable valuations and believe that navigating the opportunities and challenges in 2024 will require a more nuanced approach focused on companies that can withstand the impact of higher rates. Monitoring balance sheet strength has always been prudent, but that approach has become even more critical in this higher-for-longer interest rate environment.
Garnet O. Powell, MBA, CFA is the President & CEO of Allvista Investment Management Inc., a firm with a dedicated team of investment professionals that manage investment portfolios on behalf of individuals, corporations, and trusts to help them reach their investment goals. He has more than 25 years of experience in the financial markets and investing. He is also the Editor-in-Chief of the Canadian Wealth Advisors Network (CWAN) magazine. He can be reached at gpowell@allvista.ca