Equity Overview

All sectors gained in December.  Real estate stocks led the way as 30-year fixed rates fell below 7% for the first time since August and the market anticipated further rate cuts.  Energy stocks were the weakest.  Value stocks outperformed growth stocks for the month, but growth outperformed value for the full year.

Market volatility was modest, as the S&P 500 moved by 1% or more on only 3 of 20 trading days.

Stock valuations became slightly frothy as the 12-month forward price/earnings ratio for the S&P 500 inched up to 19.3, above the 5-year average of 18.8.

Macro Overview

Three broad themes drove stock performance in 2023:  inflation, interest rates, and the widescale emergence of artificial intelligence.

The unrelenting inflation in consumer and producer prices which dogged stocks in 2022 slowed significantly in 2023.  The CPI, which increased at a reported annual rate of 9.1% in June 2022, stood at 3.1% in December 2023.

Of course, this dramatic moderation in price increases was not an accident.  It was the result of the Fed’s determination to raise interest rates and keep them high until inflation slowed.  Implementing that policy, the Fed raised rates 11 times, from a range of 0.00% to 0.25% in March 2022 to a range of 5.25% to 5.50% in July 2023, where it remains.

As we noted in our December 2022 newsletter, the fear among economists was that the steady drumbeat of rate increases would stifle economic growth and lead to a recession.  But it hasn’t happened.  Instead, economic activity and employment have remained robust and the consensus now is that the Fed may have achieved the proverbial “soft landing,” curbing inflation without draconian consequences to the broader economy.  The stock market, which hates inflation and loves stability, has reacted accordingly.

The subtext in 2023, and potentially a dominating theme in years to come, was the mainstreaming of artificial intelligence.  It is difficult to grasp, at this relatively early stage, exactly what the impact will be on the world as we know it.  But Jensen Huang, the CEO of Nvidia, whose microchips are powering the AI explosion, recently stated: “Generative AI is the single most significant platform transition in computing history.  In the last 40 years, nothing has been this big. It’s bigger than PC, it’s bigger than mobile, and it’s gonna be bigger than the internet, by far.”  That may be hyperbole, coming from someone with a vested interest.  But it may also not be an accident that the so-called “Magnificent Seven” (Alphabet (Google), Amazon, Apple, Meta (Facebook), Microsoft, Nvidia, and Tesla)–which together generated more than 60% of the gain in the S&P 500–are all in the forefront of AI development.