What a difference a year makes.

At the beginning of 2023, I told clients to expect a strong, rebounding market.

At the time, bearishness among investors was near an all-time high after a sharp market decline in 2022. In fact, the vast majority of economists and market strategists were predicting a recession to unfold by midyear.

Yet, my rationale for being bullish was based on a few crucial historical patterns and trends. Specifically, I cited that markets rarely double down on yearly declines and that the third year of the presidential election cycle was far and away the strongest year for stocks. I also stated that inflation would likely continue to fall, the Fed would eventually pause, and that economists had consistently underestimated the underlying strength of the U.S economy.

Check on all of the above.

However, it should be noted that the powerful year-end rally of 2023 “lifted all boats” as the saying goes. Returns began to broaden out beyond mega-cap tech and included various sectors and market capitalizations. This is a welcome and bullish signal for 2024.

So yes, what a difference a year makes. At this time last year, most investment firms were preparing for a recession and a potential retest of the October 2022 stock market lows. Yet, the overwhelmingly negative consensus about the economy and the markets turned out to be overwhelmingly wrong. The “Magnificent Seven” carried the market for the first nine months of the year as artificial intelligence (AI) became the biggest paradigm since the internet. A recession never materialized, inflation cooled substantially, and despite higher rates, the economy held up quite well. And stocks benefited.

The key questions for financial markets in 2024 will be the direction of inflation and pace of interest rate cuts. Our view is that the risk of a recession is higher than a resurgence of inflation. Indeed, markets have priced in six quarter-point rate cuts for this year. I believe the economy is stronger than this implies, and a more likely outcome is three to four rate cuts. Regardless, we do not see a significant recession unfolding, and if the 10-year Treasury yield remains below 5%, stocks can have a nice year.

The major economic challenge that companies face right now is a skilled labor shortage, and AI will help dramatically increase their efficiency. Needless to say, productivity gains are crucial for companies to generate higher profits over the long term.

If you told me that at the beginning of 2023 the Fed would hike interest rates four more times, reduce their balance sheet by $850 billion, and there would be a regional banking crisis, I would have been hard pressed to believe the market would generate 20%+ returns. Add to that a worsening geopolitical environment. But there is good instruction here. Markets have always climbed a “wall of worry” and with a highly divisive election taking place in 2024, we encourage investors to keep their eye on the ball – that is, staying invested for the long run in great-growth companies.

No doubt, politics makes for great theater. And the elections in 2024 will have all of that, especially with the likely Biden-Trump rematch. But from our vantage point, markets ultimately focus on the economy, interest rates, and earnings. At this time, we are cautiously optimistic that the backdrop in all three of these areas remains constructive.

Of course, beyond election rancor, many risks remain. The escalation of war, a deeper-than-expected recession, inflation/interest rates moving unexpectedly higher, or some other unpredictable “black swan” events could derail stocks. On a long-term basis (and maybe even in the short run), our nation’s unsustainable fiscal path could eventually lead to sharply higher interest rates. However, in my 37 years of investment experience, I have found it is foolish to bet against American innovation. I’m not going to start now.

Even with the strong stock market of 2023, I am aware stocks are just about where they were at in November 2021, the previous market high. But we believe the trend is upward and your portfolio companies, on the whole, continue to report record profits.

Here’s to a healthy, happy, and prosperous 2024!

Best Wishes,

James Burns, CFA