Current Outlook & Portfolio Strategy
Posted on February 14, 2024
As we review the prior year and look ahead to 2024, we find ourselves pleasantly surprised by the broad-based performance of capital markets in 2023. Most global stock markets rose by more than 10% and fixed income (bonds) were also productive assets to own throughout the year. Despite ongoing concerns about the persistence of inflation, corresponding Fed policy, and geopolitical upheaval, capital markets moved higher, particularly in the fourth quarter.
While the breadth of stock market performance improved throughout the year, growth-oriented stocks outperformed more mature dividend-paying companies, highlighting the importance of having both segments of the stock market adequately represented within a well-diversified portfolio. Bonds were additive to portfolios as well. Short- and longer-term maturity fixed income instruments provided income and price appreciation throughout the year.
The Fed held its last formal meetings of the year on December 12th and 13th. The Fed’s ‘Summary of Economic Projections’ revealed that committee members believe the Fed is done raising the federal funds rate, which remains at 5.25 – 5.50%. Moreover, the probability that the Fed will begin reducing the federal funds rate at some point in 2024 has increased. This confirms that the Fed believes the work they have done over the last few years to combat persistently higher inflation is coming to an end. Moving the federal funds rate lower towards the Fed’s longer-term target of approximately 2.5% is the next likely course of action. Just as the timing and size of rate increases were difficult to predict, we anticipate the same to be true for rate decreases.
The bond market responded rapidly to the Fed’s December meeting. The 10-year Treasury dropped below 4%, after being as high as 4.9% just a few months prior, revealing the persistent volatility across much of the bond market. This also highlights why we have focused our bond ownership across shorter-term maturity bonds. Higher yields and less interest rate risk is a more favorable environment for the majority of our clients. We prefer predictability and will likely maintain shorter-term bond exposure within client portfolios until the yield curve, which remains inverted, normalizes and compensates longer-term investors appropriately.
As we enter a new year, our investment team is cautiously optimistic. On one hand, we should anticipate that tight Fed policy (higher rates) will have its designed impact of slowing economic growth. So far, our economy has proven to be rather resilient. Inflation has subsided without a commensurate move lower in economic activity. However, we know there can be a substantial lag effect to Fed policy. It’s certainly possible that the Fed may indeed orchestrate the so called “soft landing” – reducing inflation without damaging economic growth – but risks to the broader economy certainly remain.
For these reasons, we will be reviewing our clients’ asset allocation. For the past many years, we have been very willing to own a higher proportion of equities (stocks) across client accounts, particularly when interest rates were near zero. Now that interest rates are substantially higher, we are adjusting. In many cases, we can add lower-volatility, fixed-income (bond) investments to client portfolios without materially impacting forward return expectations. As always, these decisions will be made after considering the various aspects of each client relationship, which are inherently unique. Regardless of the appropriate asset allocation between stocks, bonds, and cash, valuation always matters. Adhering to our investment philosophy and approach – sourcing high-quality investments at attractive valuations – will remain at the forefront of our investment decision-making process. As always, we stand ready to review your portfolio to assure it aligns with your needs and goals.
Ian N. Breusch, CFA
Chief Operating Officer | Senior Portfolio Manager
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