Q4 2023
January 4, 2024
You will note the stock market finished 2023 on a very strong note; at, or near, all-time highs. The 4th quarter was particularly strong with the major indices rising between 12% and 14%. Of particular note is the market ending the year having fully recovered from 2022’s decline.
I hope someday soon I will be able to talk about a good stock market without mentioning interest rates or the Federal Reserve. I imagine no one would be more appreciative of a new narrative than you; today is not that day.
The 4th quarter’s performance was wholly driven by a renewed hope that interest rates have peaked. Actually, it was more than hope, as Fed Chairman Powell came right out and said it. Interest rates are likely at their peak for this cycle. Words akin to pouring gasoline on a fire.
Then, as is always the case, expectations quickly evolved. The peaking interest rate narrative soon became expectations for interest rate cuts in 2024. It is no wonder the market did so well. My tone may sound a bit skeptical. It is.
Please do not take my tone to mean I am wholly pessimistic in my outlook for the market. The economy has been resilient these past few years. Despite inflation, labor shortages, logistic snafus, and higher interest rates, the economy has held up well.
What I hope for is less micro-management from the Fed. For the life of me I can’t understand why they are letting interest rate cuts seep into the discussion. Interest is the cost of money, and the price of money is not 0%, 1%, or even 2%.
We allowed rates to fall to those levels to stem economic disasters. First it was a real estate bubble (2008), then a pandemic (2020). In both instances, it worked. What we have found though, is that once implemented, the cheap money policy is difficult to reverse.
Years ago, I wrote that economic theory foretells the end of cheap money to be rampant inflation. I recently speculated that 2022’s inflation was caused by cheap money. The truth is we cannot be certain what caused the inflation. It could have been fiscal spending, the low interest rates, the effects of shutting down and then reopening the world’s economy, or some combination thereof. What we do know is that once inflation rears its head, the only policy response is to raise interest rates.
As we sit here today, I ask: why should the Fed even consider cutting interest rates, when the economy is doing just fine? We are not in a recession; we do not need stimulus and there is no impeding economic disaster. Why go back to a cheap money policy when it is no longer needed?
The answer is of course “vested interests”, those who have thrived in a low-rate environment. But from a public policy perspective, it is utter nonsense. I hope cutting rates in 2024 is quickly taken off the table. If we take interest rate cuts off the table, the market can move on to fundamentals.
What is the outlook for business? I see a mixed bag today, with the trends moving in a good direction. I believe business inventories are still high relative to demand, but they are trending down. This will resolve itself over the coming year or so.
I think labor shortages are a structural problem and not going away anytime soon. Labor costs will remain an issue for the foreseeable future. That is bad for business margins (the micro effect) but good for aggregate demand (the macro effect). Near term it will hold back valuations, longer term managements will address the issue favorably.
Revenue is growing modestly. Earnings will grow, but at a lower rate as higher costs are absorbed. Both are, however, growing.
We are also coming into a Presidential election cycle, but I have not, nor do I now, feel the election will drive the market one way or the other. Policy directions resulting from elections matter, but election years are typically not big policy change years.
With that, I wish you a very Happy New Year!
Sincerely,
Mark Hoonsbeen, CFA
Nicollet Investment Management