Market Commentary – December 2023

The year 2023 was dominated by inflation and the Federal Reserve's restrictive policy in response to it. The year began with inflation at about 6.5%, with the Fed raising interest rates despite fears of rising unemployment and an economic recession. But while the focus remained on inflation, several other events occurred during the year, including the political battle over the debt ceiling and a potential government shutdown, the collapse of several banks, labor strikes and unrest in the Middle East.

In March 2022, the Federal Reserve began to aggressively raise interest rates as part of a restrictive policy aimed at reining in escalating inflation. In 2023, there were signs that the Fed's monetary policy was paying off. Price growth slowed, apparently without triggering a recession.  The personal consumption expenditures price index was 5.4% in January, while core prices, excluding food and energy, were 4.7%. Other than a moderate surge during the summer, the PCE price index trended lower, with the last reading at 2.6% (core prices were 3.2%) for the 12 months ended in November.

While inflation has turned lower, it remained above the Fed's 2.0% target. However, the progress in moderating price pressures allowed the Fed to refrain from further interest rate hikes since July. In addition, recent Fed projections indicate rate cuts of 75 basis points in 2024, possibly in the form of three 25 basis point rate reductions, although changes in the economy or inflation could prompt the Fed to alter its course of action moving forward.

Raising interest rates may have helped drive down inflation, but it also had the unfortunate effect of cooling the housing market. Rising interest rates also carried over to mortgage rates, which vaulted higher, peaking at about 8.0% in October, more than double the mortgage rate during the pandemic and well above pre-pandemic levels. Higher mortgage rates translated to fewer buyers. However, home prices climbed higher year over year, primarily due to diminishing inventory. Fortunately, mortgage rates have fallen by more than a full point over the last few months of the year, settling at about 6.61% at the end of December.

In a span of a few weeks in March, three small-to-mid size U.S. banks failed, which prompted investors to lose confidence in the banking industry and sent bank stocks plummeting amid fears that more bank failures could follow. Losses on cryptocurrency investments, falling real estate investments, downturns in bond portfolios, and a run on bank deposits triggered the banking collapse. A potential escalation was likely averted by the Federal Reserve, which provided emergency loans to distressed banks, while ensuring that all deposits would be honored.

As if interest rate hikes and bank failures weren't enough to digest, investors spent the first half of the year dissecting rhetoric over the debt ceiling crisis. In mid-January, the United States hit its debt ceiling, which prompted a political back-and-forth until the beginning of June, when an agreement was reached. The result was new legislation, the Fiscal Responsibility Act of 2023, which effectively raised the debt ceiling but capped federal government spending.

The U.S. economy proved to be resilient in 2023. Gross domestic product expanded during each of the first three quarters of the year, increasing 2.2% in the first quarter, 2.1% in the second quarter, and 4.9% in the third quarter. Consumer spending, the linchpin of the economy, also showed strength, climbing 3.1% in the third quarter. Consumers spent on both goods and services throughout the year.

The employment sector, expected by some to slow with rising interest rates, maintained strength throughout the year. While the number of new jobs trended lower during the second half of the year, job growth averaged 240,000 through November. There were 6.3 million unemployed in November 2023, compared to 6.0 million a year earlier. The unemployment rate was 3.7% and remained within a range of 3.5%-3.8% for most of the year. Average hourly earnings increased by 4.0% in 2023. The number of job openings decreased during the year but remained solid at 8.7 million.

One of the primary factors in the drop in overall inflation was a decline in energy prices. According to the Consumer Price Index, energy prices fell 5.4% over the 12 months ended in November (latest CPI data available). Gasoline prices dropped 8.9% over the same period. Food prices, on the other hand, rose 2.9%, while prices for shelter increased 6.5%.  Total industrial production declined 0.4% through November (latest data available). Manufacturing, which accounts for about 78.0% of total production, decreased 0.8%. A lengthy strike by U.S. auto workers impacted motor vehicle production in particular, and overall manufacturing in general. However, in addition to the impact of striking workers, manufacturers faced higher borrowing costs and weaker demand for goods.

As 2023 drew to a close, there were some positives to consider upon entering the new year. The GDP expanded at a greater-than-expected pace in the third quarter, and crude oil and gas prices reversed course and dipped lower. Primary inflationary indicators, such as the Consumer Price Index and the personal consumption expenditures price index, trended lower at the end of the year. If interest rates decrease, borrowing will be available to more consumers, which should help the housing sector. Stocks enjoyed a solid bounce back in 2023. If corporate earnings continue to rebound, that would bode well for stocks in 2024. There are factors that will come into play next year, but how they impact the economy and markets is open to speculation. How much longer will the Russia/Ukraine war last, and how much more financial aid will be coming from the United States? The Hamas/Israel conflict could expand to include other countries, impacting other lives and economies. And, of course, 2024 brings with it a presidential election.

*Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark the performance of specific investments.

Last Month’s Economic News

• Employment: Job growth was stronger than expected in November, with the addition of 199,000 new jobs after adding 150,000 new jobs in October. Monthly job growth has averaged 240,000 over the prior 12 months, compared with 375,000 per month in 2022. In November, the unemployment rate declined 0.2 percentage point to 3.7% and has remained in the range of 3.5%-3.7% since March. The number of unemployed persons edged down 215,000 from October to 6.3 million. In November, the number of long-term unemployed (those jobless for 27 weeks or more) edged down to 1.2 million. These individuals accounted for 18.3% of all unemployed persons. The labor force participation rate inched up 0.1 percentage point to 62.8% in November (62.3% at the end of 2022). The employment-population ratio increased 0.3 percentage point to 60.5% in November (59.9% in November 2022). In November, average hourly earnings increased by $0.12 to $34.10. Over the past 12 months ended in November, average hourly earnings rose by 4.0% (average hourly earnings were $32.82, up 4.6% in 2022). The average workweek decreased by 0.1 hour to 34.4 hours in November, the same as in November 2022.
• FOMC/interest rates: As expected, the Federal Open Market Committee maintained the target range for the federal funds rate at the current 5.25%-5.50% following its meeting in December. In arriving at its decision, the Committee noted that the economy had slowed and that inflation, while it had eased, remained elevated. As to future policy actions, the FOMC provided that "In determining the extent of any additional policy firming that may be appropriate to return inflation to 2.0% over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments." In addition, the Committee's projections for the federal funds rate indicate the possibility of three 25 basis point rate decreases in 2024.
• GDP: The economy, as measured by gross domestic product, accelerated at an annual rate of 4.9% in the third quarter, following increases of 2.2% in the first quarter and 2.1% in the second quarter. A year ago, GDP expanded at an annualized rate of 2.7% in the third quarter. Consumer spending, as measured by the personal consumption expenditures index, rose 3.1% in the third quarter, higher than in the second quarter (0.8%) but less than the first quarter (3.8%). Spending on services rose 2.2% in the third quarter compared with a 1.0% increase in the second quarter. Consumer spending on goods increased 4.9% in the third quarter (0.5% in the second quarter). Fixed investment advanced 2.6% in the third quarter (5.2% in the second quarter). Nonresidential (business) fixed investment rose 1.4% in the third quarter after jumping 7.4% in the previous quarter. Residential fixed investment jumped 6.7% in the third quarter, following a 2.2% decrease in the second quarter. Exports rose 5.4% in the third quarter, compared with a 9.3% decrease in the previous quarter. Imports, which are a negative in the calculation of GDP, increased 4.2% in the third quarter, after declining 7.6% in the second quarter. Consumer prices increased 2.6% in the third quarter (2.5% in the second quarter). Excluding food and energy, consumer prices advanced 2.0% in the third quarter (3.7% in the second quarter).
• Inflation: The Consumer Price Index for November supported the notion that inflationary pressures are trending lower. The CPI rose 0.1% after being unchanged in October. Over the 12 months ended in November, the CPI rose 3.1%, down from 3.2% in October. Excluding food and energy prices, the CPI rose 0.3% in November and 4.0% for the year ended in November, unchanged from the 12-month period ended in October. Energy prices fell 2.3% in November, while food prices rose 0.2% and prices for shelter rose 0.4%. For the 12 months ended in November, energy prices decreased 5.4%, while food prices rose 2.9% and shelter prices advanced 6.5%. Gasoline prices dropped 8.9% over the last 12 months, while fuel oil prices fell 24.8%. In another sign of waning inflation, prices that producers received for goods and services were unchanged in November following a 0.4% decline in October. Producer prices increased 0.9% for the 12 months ended in November, down from a 1.3% increase for the year ended in October. Producer prices less foods, energy, and trade services inched up 0.1% in November, while prices excluding food and energy were flat. For the 12 months ended in November, prices less foods, energy, and trade services moved up 2.5% (2.9% for the 12 months ended in October), while prices less foods and energy increased 2.0% (2.4% for the period ended in October). In November, prices for food rose 0.6% but fell 4.9% year over year, the largest drop since December 2015. Energy prices were down 2.1% in November and 8.4% since November 2022.
• Housing: Sales of existing homes increased 0.8% in November, marking the first monthly increase in the last six months. Existing home sales dropped 7.3% from November 2022. The median existing-home price was $387,600 in November, lower than the October price of $391,600 but 4.0% higher than the November 2022 price of $372,700. Unsold inventory of existing homes represented a 3.5-month supply at the current sales pace, down slightly from October (3.6 months) but above the 3.3-month supply in November 2022. Sales of existing single-family homes increased 0.9% in November, the first monthly increase since February. Over the 12 months ended in November, sales of existing single-family homes were down 7.3%. The median existing single-family home price was $392,100 in November, down from $396,000 in October but 3.5% above the November 2022 price of $378,700. New single-family home sales declined in November, falling 12.2% after dropping 4.2% in October. However, sales were up 1.4% from November 2022. The median sales price of new single-family houses sold in November was $434,700 ($414,900 in October). The November average sales price was $488,900 ($498,500 in October). The inventory of new single-family homes for sale in November represented a supply of 9.2 months at the current sales pace, the largest supply of new single-family homes for sale nationwide this year.
• Manufacturing: Industrial production increased 0.2% in November, following a 0.9% decrease in October. Manufacturing advanced 0.3% in November, driven higher by a 7.1% jump in motor vehicles and parts production following the resolution of strikes at several major automakers. Manufacturing excluding motor vehicles and parts decreased 0.2%. Mining rose 0.3%, while utilities fell 0.4%. Over the past 12 months ended in November, total industrial production was 0.4% below its year-earlier reading. For the 12 months ended in November, manufacturing increased 1.3%, utilities advanced 3.5%, while mining declined 0.4%. November saw new orders for durable goods increase 5.4%, marking the second monthly advance out of the last three months. Durable goods orders declined 5.1% in October. New orders for durable goods rose 14.5% since November 2022. Excluding transportation, new orders increased 0.5% in November. Excluding defense, new orders increased 6.5%. Transportation equipment, up two of the last three months, led the November increase, advancing 15.3%.
• Consumer confidence: Consumers ended 2023 with a surge in confidence and restored optimism for 2024. The Conference Board Consumer Confidence Index® increased in December to 110.7, following a 101.0 reading in November. The Present Situation Index, based on consumers' assessment of current business and labor market conditions, rose to 148.5 in December, up from 136.5 in the previous month. The Expectations Index, based on consumers' short-term outlook for income, business, and labor market conditions, improved to 85.6 in December from 77.4 in November.

Eye on the Month Ahead

Will waning inflation and slowing job growth prompt the Federal Reserve to lower interest rates in 2024? And if interest rates are decreased, what impact will that have on the bond and stock market? Crude oil prices and retail gas prices declined in 2023. However, the ongoing conflict in the Middle East, coupled with a cut in production, could force prices for both commodities higher this year. Lastly, 2024 is an election year, the results of which will almost certainly impact the economy in general and Wall Street in particular.