Market Update: December 28th, 2023

The 2023 Year End Review!!

Once again, we have completed our annual trip around the sun and once again this has not been a dull year. The big story in the market was the fastest rise in interest rates ever which put a strain on many areas of the financial sector as well as people’s pocketbooks. Over the past few years there have been unprecedented events, whether it be a global pandemic/lockdown, record inflation, Russia invading Ukraine, or an Israel/Gaza War, our lives and the market have been bounced around like a yo-yo.

Year End Topics

Technology Up, Down, and Up

Interest Rate Rise Hits Home and Homes/Long Assets

2024 Look Forward

Technology Up, Down, and Up

Technology has taken everybody on a 3-year roller coaster ride. One of the best-performing sectors in 2021, the worst-performing sector in 2022, and now the best-performing sector in 2023. “The Magnificent Seven” (Nvidia, Meta, Tesla, Amazon, Google, Apple, and Microsoft), seem to have a love/hate relationship with the investing world. Up about 40% in 2021, down about 40% in 2022, and finally up about 50% in 2023. This was a special year because in 2023 they made up about 70% of the gains of the market.

For the largest public companies on the globe, these are quite volatile returns. Trillions of dollars have moved in and out of these companies over the past 3 years. 2024 will be another test for them as once again their valuations are approaching the higher end of their ranges. Near the end of 2021, the Forward PE Ratio for the Technology Sector hit 45x and then proceeded to drop throughout 2022. Currently, the Technology sector sits at 45.8x as of Dec. 26, 2023.

The pricing in this sector remains quite high with very little earnings or revenue growth to show for it. This is concerning as they will need to justify these prices with better earnings going forward.

While this is the most “overvalued” area of the market, these are the companies providing the greatest exposure to the fastest-growing areas of the market. Artificial intelligence, semiconductors, cloud computing, etc. all are changing our lives, but we will need to see them derive better earnings to justify these prices. This will be especially tough in a “higher for longer” interest rate environment.

Interest Rate Rise Hits Home and Homes/Long Assets

The rapid rise in interest rates has hit everyone in in the wallet with mortgage and borrowing costs rising substantially throughout the year. This has also hurt long-dated income-paying assets, which is the main reason for the failure of multiple banks in the US. The banks held many long-dated bonds on their balance sheets and those got hit very hard due to the sharp rise in interest rates. This made certain banks unable to fulfill their deposit obligations when customers wanted their money back and as a result, those banks failed. This was also an issue of those banks taking greater risks and potentially over-leveraging themselves. While this was a headline example, this happened across many sectors last year and continues to happen. People and businesses have been having a difficult time paying the higher rates and assets just are not worth as much as they used to be when rates were low. There is a segment of businesses and people who have done the same who maybe took on too much risk or over-leveraged themselves.

While there are some businesses and individuals in tough spots. While a person may have over-leveraged themselves to purchase a home, that doesn’t mean all people with a home and mortgage are in a bad spot. A good example of this is one of the worst sectors in 2023, Utilities. 

While this is a weak performer in 2023 with the prices dropping, the revenue remains stable, and earnings continue to grow. This is an area that has faced increased costs in borrowing but has managed to increase earnings even in these difficult times. This could be a turnaround story in 2024 if rates (one of their largest costs) continue to decline.

2024 Look Forward

2024 could be another interesting year there is potential for a valuation correction in the S&P 500, and a potential interest rate drop globally, and we will start the 2024 US Presidential Race watch.

Valuations in 2024

The overall market and “Big Tech” (Magnificent Seven) are a little extended right here. We can see this as represented by the Shiller PE Ratio which takes the current earnings vs. the last ten years adjusted for inflation. 

The typical range of this ratio in the last 10 years for this ratio is between 26 on the low end and 33 on the high end, currently we sit around 33. This isn’t outrageous but it’s not cheap. This is mostly pushed up by Big Tech valuations and considering they represent a large portion of the S&P 500, that index might not be the best bang for your buck going into 2024. A better investment may be to overweight the lesser-known names than the biggest names of 2023.

Interest Rates in 2024

Another story to watch will be interest rates and their drop in 2024. It is pretty much consensus that rates will be coming down. The real story will be the reason that they are coming down and the rate at which they fall. This could be the result of poor economic conditions or a drop in inflation. If it’s the former the drop will be more rapid and if it’s the latter the drop will be slower. Ideally avoiding poor economic conditions would be preferred, but if the world were to slow down economically it is likely the higher valuation sectors could take the biggest hit. 

The US Federal Reserve Dot Plot shows the members' estimate of where they see rates going over the next 3 years. This shows 2.5% of interest rate cuts over the next 3 years with 0.75% in 2024 and about 1.00% in 2025.

US Elections in 2024

Get ready for the show because it’s that time again. The US Presidential elections will take place in November 2024, therefore once again we will have to weigh the options of a Democratic and Republican President going forward. 

On a positive note, the average return in an election year is 6.1%. Not as good as Year 3 (2023), but still positive on average. This will be a storyline throughout the year therefore we will not ruin the remainder of your year with this right now.

All the best to a prosperous 2024!

‍

Sincerely,

Justin, Konrad, and Merriel

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Content Sources: Bloomberg, Trading Economics, Yahoo Finance, BCA Research

Disclaimer: This newsletter is solely the work of Justin Lim and Konrad Kopacz for the private information of their clients. Although the author is a registered Investment Advisor with Echelon Wealth Partners Inc. (“Echelon”) this is not an official publication of Echelon, and the author is not an Echelon research analyst. The views (including any recommendations) expressed in this newsletter are those of the author alone, and they have not been approved by, and are not necessarily those of, Echelon.

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