It was once said that there are years where decades happen, and 2023 certainly felt that way.

From crises averted to ongoing geopolitical turmoil, falling inflation to a resilient economy, rate hikes to the anticipation of rate cuts, it’s almost easy to forget just how much we saw this year. As 2024 comes into view, let’s take stock of the more important developments we saw through 2023 – and what they could mean moving forward.

Crisis Averted: US Banking Industry

The year started out with a massive run up in treasury yields that began in mid-2020 nearly resulted in financial catastrophe for the US banking industry. Almost overnight, investors everywhere did their best to wrap their heads around the risks inherent to banks’ balance sheets and to understand the accounting differences between held-to-maturity and available-for-sale securities.

On March 8th, Silicon Valley Bank announced that it would book a large loss after being forced to sell investments to cover withdrawals. This sparked fear among depositors, who in turn raced to withdraw their funds. By Friday, March 10th, shares of the Bank were halted as US regulators moved to seize control of the bank. While they promised insured depositors would be made whole, questions abounded about uninsured depositors. As the weekend progressed, it became clear that the risk of financial contagion was massive, and regulators were forced to act.

So, act they did. Among a number of measures announced was the Bank Term Funding Program, or BTFP, which allowed banks to pledge their US Treasury holdings at par value and borrow against them in order to shore up their balance sheets. The result of this policy, and others, was to ultimately calm the market and set the stage for a significant rally in US equities.

Questions remain, however, about potential risks lurking in the banking sector: Have we seen the last of the risks posed by rising rates? What about issues stemming from lending to the property sector? These are some of the questions investors should be asking as we move into 2024.

Geopolitics

2023 was another year in which geopolitics remained center-stage for global investors.

While war continued to rage on the European continent, the world continued to grapple with the idea that the United States was facing great power competition from the second largest economy in the world. While relations between the US and China may have stopped deteriorating for the time being (and even this is highly debatable and likely to be short-lived as we move into election season in the US), this long-term trend is unlikely to abate, and we continue to feel very comfortable with our positioning in defense stocks in part as a hedge against ongoing stresses.

Unfortunately, geopolitical issues did not remain contained to the Russia-Ukraine war and the great power conflict between the US and China. The world was forced to grapple with the horrific terrorist attacks waged by Hamas against the Israeli population on October 7th and the subsequent response from Israel. While market impacts have been limited to date, the potential for escalation remains very real and investors must stay vigilant.

The US Economy: From Good to Great

No discussion of 2023 could be complete without a tip of the hat to the US economy, and more specifically to the US consumer. For all the talk of recession and economic weakness, it’s fair to say that the lagged impact of one of the most aggressive tightening cycles we have ever seen has yet to be felt in the US economy at large.

The chief reason for the resilience we have seen has been the “King Consumer.” Despite factors including elevated inflation levels that have weighed on consumer confidence and significantly tighter lending standards, the consumer has shown remarkable resilience. You can ascribe this to a number of different reasons. It could be the lagged impact of fiscal stimulus boosting savings that has yet to be run through. It could be high levels of household net worth that are supporting spending. It’s certainly partly attributable to a still strong labor market and positive real wage growth. But no matter the factors, the outcome remains the same – resilience.

Other factors have contributed to economic strength as well. For instance, massive investments in certain industries such as semiconductor manufacturing have supported strength in non-residential construction. Government consumption has also been a net positive this year.

The question, then, is how long can these dynamics persist? Massive greenfield investments in certain industries are unlikely to repeat, downward pressure on profits may well curtail capital expenditures in other areas, and global demand looks set to weaken further. We are starting to see cracks in the labor market and the cushion from savings is running down, so how long can the US consumer continue to keep its head above water?

Higher for Longer…No More?

Much of the narrative surrounding the rise in bond yields through October was driven by the idea that the Fed would remain tighter for longer than the market was expecting. This, in turn, stemmed from a combination of factors including a resilient economy and the Fed’s desire to ensure that its battle against inflation would result in a durable victory.

As the year progressed, though, headline CPI continued to move lower. This was led by the continued decline in goods inflation, but also by a steady move lower in the all-important services inflation number. By mid-October, the market more firmly changed its mind and began to price in more aggressive cuts from the Federal Reserve in 2024. Thus, the higher-for-longer narrative began to flip, yields rolled over, and equities rallied.

The question as to when and how aggressively the Federal Reserve will ultimately cut is far from answered in our mind. Inflation remains well above the Fed’s target rate of 2% and we cannot rule out a reacceleration in inflation. It is also possible that the market is right about getting significant cuts, but for the wrong reason. A Fed cutting rates aggressively in response to an economic downturn would certainly not be the gift to markets that many are hoping to receive early next year.

A Magnificent Year

Against the backdrop described above, we saw truly spectacular equity market performance from a small handful of mega-cap names, dubbed the Magnificent 7 or Mag7 (Apple, Amazon, Alphabet, NVIDIA, Meta, Microsoft, and Tesla). The so called Mag7 returned over 100% year-to-date, versus 21% for the S&P 500 and 9% for the S&P 500 excluding the Mag7.

This type of performance from a small handful of mega-cap stocks is simply incredible. It was fueled by things ranging from excitement about Artificial Intelligence to resilient growth and washed-out valuations, for some. In any event, the result has been a concentration in market cap that has historically not been sustainable. The question is whether or not this can last. What would a reversal potentially look like? Is it these names starting to crack, or the market catching up? The answer may well define US equity markets in 2024.

This material contains the opinions of Manning & Napier Advisors, LLC, which are subject to change based on evolving market and economic conditions. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

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