2023/2024
As the Puget Sound broke heat records this last quarter, so did the US large-cap equity market. The recent quarter’s returns were driven solely by the six largest companies, while the other 494 in the S&P 500 had negative returns. With these six companies making up 31% of the index, the market index is far from diversified. Historically, broad-based participation results in higher returns with less volatility.
This concentration isn’t sustainable, but it is explainable. With a weakening economy this last quarter, investors focused on companies they perceive as recession-proof stocks and relied on recent performance trends associated with the AI buzzword.
History doesn’t repeat but often rhymes, and this situation resembles the late 1990s when a few mega-cap stocks drove the market up. Ironically, in late 1999, as interest rates faltered, and a recession became apparent, other market sectors began to outperform.
Currently, 2.5 years into this rate hike cycle, signs of a recession are emerging. Unemployment has moved up from a low of 3.4% to 4.1%, and economic data continues to weaken. While this trend helps combat inflation, it increases recession risk the longer rates remain elevated.
Now comes the key balancing act. How much and when is the right time for the Fed to cut rates to avoid a recession, but not too early to prolong inflation? Whether the Fed gets it right or wrong, sticking to a long-term financial plan and staying invested and diversified, even in areas that haven’t done well, remain the core tenets we believe to create and maintain financial security.
For more information, please read our commentary from Brent Schutte, our Chief Investment Officer - Northwestern Mutual's 2nd Quarterly Market Commentary
As 2024 began, expectations for six Fed rate cuts have dwindled to three, with doubts emerging about any cuts materializing. This shift reflects the economy's resilience and the persistence of "sticky" inflation. The Fed's delicate balancing act persists cutting rates prematurely risks reigniting inflation, while prolonged high rates may trigger a recession. We maintain our forecast that inflation is not yet sustainably on the path to 2 percent. Consequently, the Fed is likely to maintain elevated interest rates, which could gradually erode the strength of U.S. consumers and corporations. Combined with indicators suggesting a later stage in the economic cycle, we foresee continued recession risks for the U.S. economy throughout 2024.
Although equity markets typically mirror economic trends, the market's divergence is notable, largely driven by the dominance of the 'Magnificent 7' mega-cap tech stocks, now comprising nearly a third of the total index. While these stocks have soared, their overvaluation raises sustainability concerns. Historical analysis indicates that top S&P500 companies have underperformed an equal-weighted basket of the same index
over the last 65 years. This reiterates the point that what has worked, doesn’t always continue to work over the intermediate to long term.
Diversifying across the ‘other’ S&P500 companies, mid & small caps, and international markets offer substantial opportunities, given current valuations. Additionally, fixed income investments present enticing opportunities, boasting yields unseen in decades, particularly in anticipation of the Fed's rate cuts.
In essence, predicting recession timing is challenging, but embracing diverse asset classes can help fortify investors against short-to-moderate economic downturns and position them for robust recovery.
You can read more from our Chief Investment Officer, Brent Shutte here: Why Sticky Inflation Is Making Things Difficult for the Fed | Northwestern Mutual
Last year was a great year to be invested and a reminder that headlines don’t drive returns. Some events that occurred in 2023: bank failures, continued historic interest rate hikes, inflation and recession concerns, war abroad, unemployment rate and wage growth both being a good and bad thing, and a frenzy around how AI is going to change the world. 2023 was a busy year.
Still, inflation, wage growth, and recession concerns are headlining 2024. However, the data is trending in a positive direction. If we remove shelter, a large, but lagging data point, year over year, 4th quarter inflation was up only 3.4% and trending closer to the Fed’s 2% goal.
The Fed is still fixated on elevated wages. Before we see any interest rate cuts in 2024, we anticipate there needs to be a decline in wage growth. This can be done with an increased participation rate and/or an increase in unemployment rate.
Lastly, the recession that everyone is talking about may have already occurred. Most economists define a recession as two negative quarters of GDP growth. Using that definition, we were in a recession in the 4th quarter and experienced another back in 2022. This alludes to what we refer to as rolling recessions; shallow, quick recessions.
We cannot predict if or when a recession occurs, but what we do know is the stock market typically rebounds well before one is declared, making it hard to time the market. This was evident with the positive market returns we saw in 2023, especially a very strong finish towards the end of the year.
If the 2023 headlines were cause for concern, you would have missed out on those returns, which is why we always recommend staying the course and committed to your financial plan for the long term, regardless of what headlines 2024 brings.
To read further, here is Northwestern Mutual's 4th Quarter Market Commentary from our Chief Investment Officer, Brent Shutte.