Written by: Todd Asset Management
Central banks pivoted to a pause in the fourth quarter 2023 and markets celebrated. Despite higher geopolitical tensions with a war erupting in the Middle East, stocks surged in the fourth quarter encouraged by investors’ belief that a soft landing was likely. As we look forward, we agree and continue to believe a recession is unlikely. Furthermore, earnings have been recovering and interest rate-sensitive sectors could potentially benefit from the recent decline in long-term interest rates.
Additional thoughts:
- Central banks pivoted in the fourth quarter after higher rates slowed interest rate-sensitive sectors and services spending held up. As investors became more comfortable that a soft landing was achievable coupled with the Federal Reserve (Fed) indicating they are on pause, stocks worldwide rallied, and bond yields declined dramatically.
- Markets began to broaden during the quarter as investors saw a recession may not be imminent. Emerging Markets outside of China led during the quarter in a sign that economic expectations are improving. We believe the broadening has much further to go, which could benefit non-U.S. stocks.
- Furthermore, 2024 is a big election year worldwide, with over half of global population in 60 countries holding elections. Election years have typically been relatively strong, especially when there is an incumbent running since leaders in power often look to support their economies whenever possible. As of this writing, funds are still available to distribute from the European Recovery fund as well as the U.S. stimulus bills. China has continued to stimulate their economy as well.
- In general, markets have been acting more like it is early in the economic cycle than late, with small cap indexes participating in the rally and economically sensitive groups leading during the fourth quarter. Lower rates suggest interest-sensitive components of GDP (gross domestic product) could recover. Earnings seem to be bottoming and could recover in 2024. This could support companies that benefit from the new capital spending cycle and continued broadening of the market from the recent narrow leadership.
We see European and Japanese companies becoming more competitive with their U.S. counterparts. Tight financial conditions prompted weaker GDP from rate sensitive areas like manufacturing, capital expenditures (CapEx) and housing. These factors contributed to an earnings recession; however, earnings and activity are now recovering. We expect markets to broaden as earnings growth spreads. Services continued growing, albeit slower, as consumers would not deny themselves after Covid. We expect this should continue.
Themes we continue to like include market rotation to lower multiple stocks, companies that may be beneficiaries of technology application (like AI), oil company capital discipline, and a secular recovery in commodities. Additionally, the earnings reset in financials may be complete and we may see a new capital spending cycle for infrastructure, energy, green initiatives, supply chains and defense.
In short, 2023 will likely be remembered for how wrong most forecasters were. We never saw the much-anticipated recession, markets did not collapse, and inflation subsided. This is not to say things were perfect. We experienced a very narrow market where many areas did not participate in any upside until late in the year. Geopolitics soured and stimulative measures undertaken by China and several other Emerging Markets did not gain traction. Furthermore, interest rate sensitive sectors within developed markets experienced pressure, and as we look forward, we think investors may be too optimistic about how aggressively central banks will cut rates and the prospects of inflation continuing to decline. Despite this, we expect earnings will rebound and economic growth to remain resilient. While markets are starting 2024 off by consolidating, we expect we may see better performance after it is completed. With so many elections, parties in power globally will likely seek to improve growth to better their chances of staying in power. As earnings growth spreads more broadly through markets, we expect performance should as well. Don't be surprised if this leads to a resumption of outperformance by international and value-style equities as these trends play out.
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