DECEMBER 2023 MARKET INSIGHTS
The stock market saw very strong gains in November with the S&P 500 returning 9.1%, with dividends reinvested1. As we look at the style indices, the Russell 1000 Growth Index returned 10.9% and the Russell 1000 Value Index returned 7.5% respectively. The dominance of growth continued during the month1.
In the bond market, the Bloomberg US Aggregate Bond Index returned 4.5% for the month and the Bloomberg 1-3 Year Government/Credit Index returned 1.2%1. The biggest driver of the total return in the fixed income market was the decline in interest rates over the last 30 days. The 10-year Treasury yield declined from 4.93% at the end of October to 4.33 at the end of November1. On the front end of the yield curve, the 2-Year Treasury Note yield declined from 5.09% at the end of October to 4.68% at the end of November1. The combination of a greater decline in yield and a longer duration is what drove the much higher return from the Bloomberg US Aggregate Bond Index over the Bloomberg 1-3 Year Government/Credit Index during the month.
The most recent read on inflation saw the CPI decline from 3.7% in September to 3.2% in October, however, the decline in inflation was far less pronounced when factoring out food and energy1. The CPI excluding food and energy declined by just 10 basis points in the September to October measurement period. Oil dropped by nearly $5/bbl, or 5.6%, during November and this price drop is contributing to inflation’s decline.
The labor market is beginning to show some cracks with unemployment moving up to 3.9% and job creation slowing1. The Fed continues to focus on both sides of their dual mandate of low inflation and full employment. As we know, the Federal Reserve was aggressively increasing the Fed Funds rate to combat inflation. As interest rates moved up quickly, we saw the impact on the regional banks in March, and since then the Fed has been a little less aggressive in pursuing rate hikes. We are not suggesting that the Fed is abandoning the inflation fight, but we are beginning to consider that the Fed may seek to combat rising unemployment by cutting interest rates in the early part of 2024. The notion of supporting the jobs market is driven by the fact that 2024 is an election year. It is also important to remember that the Fed will likely be less active with moves the closer we get to November because they will not want to be viewed as having done anything to tip the election in any direction.
Looking further at economic statistics, Industrial Production was down 0.7% in the last release, and capacity utilization also dropped 0.5%1. While the Durable Goods Index can be volatile, it was down over 5% and this is also causing some concern that we will continue to see some economic weakness1. As I write this on the morning of December 1st, the ISM data that was released this morning showed a manufacturing decline from 47.8 to 46.71. Any reading below 50 indicates a contractionary economic environment and this move shows that the economy is contracting more quickly than last month. ISM Prices Paid rose from 46.0 to 49.9, indicating that inflation is still with us, so the Fed still has some work to do. ISM employment dropped by nearly 2 points to 45.8, but the New Orders index rose from 46.7 to 48.31. The best way to look at the order index is that orders are declining, but the rate of decline is slowing.
When I look at the combination of the ISM releases, I see an economy that is slowing with weakening employment, but still stubborn price increases. While we are seeing the rate of inflation come down, it is still well above the Fed’s target range, and this is the reason that we need to continue to watch inflation relative to economic growth. In the best scenarios, inflation declines to the Fed target range, the Fed reduces the Fed Funds rate, and the 10-year Treasury stays in a range of 3.5% to 4.0% with the traditional 2% premium for the 10-year Treasury over inflation. In the worst scenarios, inflation accelerates from here, the Fed continues to hike rates resulting in more economic slowing and rising unemployment, and we enter a period of stagflation. In this environment, the Fed will likely focus on tamping down inflation first to allow the economy to heal and then work on cutting rates to help revive economic growth and employment. The likely scenario is somewhere in the middle.
Geopolitically, the war in Ukraine rages on and both sides appear to be digging in for a long winter fight. Ukraine can resolve this by ceding territory to Russia though this is something they should not and will not do to stop the war. Russia could end things by withdrawing troops from Ukraine, though Putin needs to continue to appear strong at home and abroad making this unlikely. It seems we end up with a stalemate until a solution for peace can be constructed in a way that maintains Ukrainian sovereignty while Russia is not made to lose too much face. In Gaza, with the ceasefire over, Hamas has lobbed more missiles in Israel’s direction while Israel continues to root out Hamas. The world remains in the most fragile state since the end of the Cold War.
I want to end on a more positive note. As we come into the Christmas season, we still have so much to be thankful for in our lives and we should really look for the good with our loved ones as we anticipate the birth of Christ and we put a wrap on 2023. Everyone at Knights of Columbus Asset Advisors wishes you and your families a blessed and Merry Christmas and a Happy New Year!
Until next month and year.
