Broker Check

4th Quarter 2023: The End Is Here, But Where Is The Recession?

January 09, 2024

When the economists were publishing their forecasts for 2023, a recession was the base case and seemed all but baked into what one should have expected last year. The only variables in question were the magnitude and when the recession would actually begin. And the recession drum continued to beat all year long, but a recession did not manifest itself in 2023. Instead the S&P 500 was up 24%, GDP was +4.9% in the 3rd quarter with a 2.9% annual run-rate, and unemployment is running at 3.7%, hovering near the lowest recorded unemployment in the last five decades (April 2023 at 3.4%). While none of these statistics align with recession warnings, there is still the inverted yield curve, along with a host of geo-political issues. Whether you view the 3-month (5.3%) vs the 10-year (3.9%) or the 2-year (4.2%) vs the 10-year (3.9%), both illustrate the yield curve inversion that is present in the bond market. To put this simply, one can earn a higher interest rate on short-term obligations than they can long-term. This is not the historical norm; the longer one is willing to tie up their money, the higher the interest rate they should earn. Historically, when these metrics invert, specifically the 3-month to 10-year, a recession followed. The chart below illustrates this inversion and it also shows interest rates in 2022 and 2023 are nearly identical, but far higher than 2021. Additionally, the 2021 chart shows what the normal slope of an interest rate curve looks like, at least from the 3-month to 10-year period. The curve in 2021 did plateau across the longer rates as interest rates were pegged at nearly 0% for many years.



Presently the data does not seem to suggest a recession is imminent. JPMorgan produces their Guide to the Markets and provides a major update at the end of each calendar quarter. They produced a slide that shows the key ingredients that would indicate if a recession were imminent. These are the determinants that the National Bureau of Economic Research (NBER) uses in analyzing if the US economy is in a recession. Take the first data point in the heat map below (Apr 2020), the US economy was in the midst of the pandemic-imposed recession and all of the determinants were red. Fast-forward to the Nov 2023 data and all of the determinants are registering middle of the road readings, with industrial production being the only item that appears too weak, albeit slightly.





Short-term interest rates have remained elevated, mirroring what the Federal Open Market Committee (FOMC) has done with Fed Funds Rates since the first hike of the cycle in March 2022. And after 11 rates hikes between March 2022 and July 2023, the FOMC finally seems ready to pivot from the 5.25% - 5.50% range we currently find ourselves at. Short-term rates remain elevated, and the FOMC and market both are forecasting lower rates in the future. This explains why long-term rates are lower than short-term rates, indicating the belief that rates will be lower in the future. The end of the current rate hike cycle seems to be here and has contributed to the rally we have seen in the markets, both stock and bond.





At present, the last rate hike of this cycle was July 2023 and has set up the next piece of the interest rate puzzle, which is how quickly the FOMC might lower rates and how many times. The Market and the FOMC’s forecasts seem at odds with one another in 2024. The green line indicates the market believes the FOMC will lower rates from the present range down to 3.62% (3.50% - 3.75% range), which suggests nearly a 2% decrease in 2024. The FOMC (blue line), on the other hand, suggests there will only be a 0.75% decrease in 2024, down to 4.6% (4.50% - 4.75% range). Of note, is that both forecasts are aligned in 2025 and the FOMC still sees rates at 2.5% long-term. I am concerned about the timing of when the FOMC will start lowering rates and if there will be any sort of catalyst to force their hand. As a reminder, they were late to begin the hiking cycle and I question whether they will follow the same path when the time comes to lower rates. One dynamic has been made clear, Chair Powell does not want to repeat the mistakes of the Paul Volker Fed in the 1970s.




The Fed funds target rate is currently higher than inflation and that is good news for consumers, there is a real rate of interest to be earned. That also means that one can finally earn interest on deposit or money market accounts, CDs or even US Treasuries. However, you will have to hunt for these rates as most banks are not offering these higher rates in traditional checking or savings accounts. On the other end of that equation is how high interest loan rates have also risen, in particular credit cards. Presently, the average credit card rate is over 20% and some are up to 30%+! If you are a consumer that continues to carry balances on your credit cards, I challenge you to grab the December 2023 statement for all of your credit cards (if you have more than one with a balance) and add up the total interest paid in 2023. You may find this to be an eye-opening experience and one that hopefully helps you get on a path to get out of credit card debt, not utilize credit beyond what you can afford to pay off each month and start to lay out a household budget. January is a great time to start new habits. I do believe the FOMC will lower rates this year, but I feel the FOMC will exercise extreme caution on the way down. The market is alluding to lower interest rates as we have seen rates across all ends of the Treasury yield curve drop by nearly 1% since November.  




Data continues to show inflation coming down and the FOMC now has to perform a fine balancing act of bringing rates down while keeping the economy moving forward with a full head of steam. If they leave interest rates too high for too long, the economy could soon move from inflationary to deflationary. While the idea of prices coming down might seem like a good thing on the surface, deflation is not good for the economy. If prices go down, should your wage go down? That idea won’t sit well with consumers. Additionally, when prices come down consumers like to wait to see if prices will continue to move lower, this can stunt demand which then leads to less consumer spending as they wait. This would not be positive for the economy (GDP) either.

The stock market has taken all of this in stride and the S&P 500 closed a mere 27 points off of the all-time high logged back on January 3, 2022. To put that another way, the S&P 500 was up 24.23% in 2023 (price basis) and only 0.56% below the all-time closing high. The bull market that we find ourselves in the midst of began on October 12, 2022, and through the end of 2023 the S&P 500 is up 33.35%.  



Worth noting is the comparison of sentiment versus reality. I have already covered the recession calls versus the reality (a recession has not transpired, as of yet). There is also the reality is that the market was up over 20% in 2023, yet a record amount of cash sits on the sidelines. One plausible explanation is that given what some money markets are yielding presently, a money market could potentially be incorporated into one’s overall investment mix. Additionally, retail investors typically late to the party and buy after the bull market is well underway. Retail investors should also exercise caution around shinny lures, or allocating too much to cash, simply because interest rates are high. JPMorgan wrote a short paper on the reasons not to allocate too much for cash as one could miss out on the potential returns on a long-term investment in the stock market.




There were a number of stories detailing how only seven stocks were driving the market higher in 2023. While that may have been true for the first half of last year, there was a pivot in the 4th quarter with broad-based participation. An efficient way to analyze this dynamic is by comparing the S&P 500 (using the SPY ETF) to RSP (an equal weighted version of the S&P 500 ETF). As a quick primer, the S&P 500 is an index consisting of 500 companies whose inclusion is determined by the S&P Dow Jones Indices. Each of these companies varies in size based on their market capitalization. To calculate market cap, one needs to take the total number of shares of stock outstanding and multiply it by the stock’s price. Both of these figures fluctuate over time, as does the size (market cap) of each company. The importance, however, is that the larger the company, the more weight it carries in the index. This weight has a direct correlation to its impact on the overall index. One could think about this phenomenon like planets in our solar system; larger planets have a greater gravitational pull than a smaller one. Apple is the largest constituent in the index. As a hypothetical example, if Apple moved 1% it could potentially move the entire S&P 500 index, whereas if the 495th constituent in the index moved the same 1%, it would have virtually no impact. Why does this matter? The S&P 500 is a market cap weighted index, and those top holdings have a more magnified impact on the index’s performance than the smaller weighted companies. When the graphic below was created, the Magnificent Seven accounted for $14.1 trillion of market cap, while the remaining 493 companies accounted for $24.13 trillion. These seven stocks alone make up roughly 37% of the S&P 500.



RSP is the same 500 constituents but with an even playing field. All 500 constituents bear the same weight in the index in RSP. By comparing the performance of the two indexes one can determine if the rally is broad based or only a select few names. As detailed below, SPY (+24%) significantly outperformed RSP (+12%) in 2023. However, in the last three months of the year RSP (+13%) outperformed SPY (11%) by almost 2%. Seeing those two indexes become highly correlated in the last quarter of the year was an indication that the rally was becoming broader.


SPY vs RSP - 2023

SPY vs RSP – Oct – Dec 2023



Each year the top Wall Street firms and their strategists publish stock market forecasts for the coming year. The first table below was published at the end of 2022 and contained forecasts for 2023. Sam Stovall was the most bullish at 4,575. The S&P 500 closed out 2023 at 4,769.83 or 4% higher than this forecast. On the opposite end of the spectrum, Barclays forecasted a close of 3,725. The market closed nearly 22% higher than this forecast. Most of the forecasts were in the low 4,000 range and well off the 2023 close.




The most bullish forecast for 2024 is Oppenheimer at 5,200, which would mean the market will be up by roughly 9%. On the other hand, JPMorgan is the most bearish at 4,200. This would mean the market will lower by nearly 12% in 2024. Nine of the fourteen strategists see the market moving higher in 2024. The one positive soundbite to share is that these forecasts are frequently adjusted as the year goes on and seldom have the forecasts been correct over the years. Trying to predict short-term gyrations in the stock market have not made for reliable forecasts. Instead, it is best to focus on a diverse portfolio that is adjusted for the investor’s own time horizon, risks, and objectives.




In closing, while the market is up 33% from the October 2022 lows and it is closing in on new all-time highs, a storm will brew at some point in the future. The mystery is we don’t know when. There will be turbulence in the market, and it will result in the market and accounts going lower. We have seen this happen throughout history and should expect this trend to continue. One of the main points that I have attempted to convey is the mystery that the market provides. The sentiment was downbeat for most of the year, and no one had expectations of a 20%+ rise in the S&P 500, but that was the reality for 2023. And despite the storms that will come in the future, the chart below is meant to remind investors to take the long-term view. When you compare the history of bull markets versus bear markets, bull markets last much longer, and we have yet to see a bear market that did not eventually fade. Stay the course.






If you have any questions or would like to discuss your personal circumstances, please do not hesitate to reach out to me.

Feel free to schedule a quick 15-minute chat with me.

Rob Leiphart, CFP®
203-220-6474
rleiphart@rbcapitalmanagement.com