2023 – A Year for Investors to Celebrate!

In this latest installment of our newsletter, we share our observations of the markets and the economy in 2023 and our outlook for 2024. Click here to go to the full report on our website.  Following are the highlights:

  • Investors found much to celebrate as 2023 came to a roaring close.  The market’s positive momentum accelerated in the fourth quarter, sending all major stock indices at or near record highs in December. 
  • Bolstered by the combination of a solid economy, better-than-expected corporate earnings, and the anticipated end to the Federal Reserve’s long rate-tightening cycle, stocks rallied strongly in the 4th quarter to finish out the year on a high note.  It was a significant reversal of the pessimism many investors felt at the start of the year.
  • The S&P 500 index posted an 11.7% total return for the fourth quarter – its best quarterly performance since late 2020 – and an impressive 26.3% total return for the year.
  • The Bloomberg Barclay’s Aggregate Bond Index erased a modestly negative return for the first nine months of the year, rallying in the fourth quarter to post a positive 5.5% total return for the full year 2023, avoiding what could have been a third straight year of losses for bonds.
  • Driving the late-year rally of both stocks and bonds was investor optimism that, in addition to ending rate hikes, the Fed may start to cut interest rates sooner than expected. 
  • After maintaining a stance for months that investors should not expect rate cuts anytime soon, the Fed released new economic projections in mid-December that suggested the possibility of three rate cuts in 2024. 
  • The primary rationale for the Fed’s pivot on rates has been the decline of inflation from its peak in June 2022.  Overall, inflation has cooled considerably from its peak of 9.1% in June of 2022 to a reading of 3.4% in December 2023.  If it continues its downward trend, it will support the narrative that the Fed should be able to “give back” some of its interest rate hikes sometime in 2024.
  • The U.S. economy has remained remarkably resilient, particularly in the face of calls by many at the start of the year for an inevitable recession.  Instead, the U.S. economy has been characterized by continued low unemployment, strong GDP growth, and solid corporate earnings.
  • Our outlook for the economy and markets in 2024 is cautiously optimistic.  If the economy continues to grow at a solid pace and corporate earnings continue to rise, then the stock market should rise further in 2024. 
  • As far as valuation, the broad S&P 500 index is fairly valued at 19.3 times forward 12-month earnings, roughly in line with its 5-year average of 18.8 times.
  • We have and will continue to find opportunities for our clients, particularly in sectors which have lagged the overall market and are thus attractively priced.  We expect value-oriented stocks, dividend-paying stocks, and other income-oriented securities, like utilities and REITs, to benefit from a broadening market rally and potentially lower interest rates in the future.
  • In the meantime, we are still favoring short-term Treasury bonds and money market funds at better than 5% annualized yields for client cash.
  • Overall, we maintain a positive long-term outlook for the U.S. economy and markets, and we believe our patient, disciplined approach to active security selection offers our clients strong long-term return potential in a cost effective and tax efficient manner.

The Edgemoor Team

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Equity Markets Remain Positive for 2023, Bonds Modestly Negative

In this latest installment of our newsletter, we share our observations of the markets and the economy in the third quarter of 2023. Click here to go to the full report on our website.  Following are the highlights:

  • The S&P 500 index maintained a strong 13.1% total return through September 30th, 2023, despite recent market volatility.  The Bloomberg Barclay’s Aggregate Bond Index, on the other hand, has notched a modestly negative return of 1.2% year-to-date.
  • In the third quarter, both indices posted negative total returns, reversing course following two quarters of gains. The S&P 500 posted a negative 3.3% total return in Q3, while the bond index returned negative 3.2% for the quarter.
  • Much of the downturn in stocks and bonds came in September, with the S&P down 4.8% and the bond index down 2.5% for the month.  This was a rapid reversal for markets, even for the month that is historically the worst for equities.
  • A major contributor to the market selloff in Q3 was the rapid rise in Treasury yields since mid-summer.  The benchmark 10-year Treasury bond reached its highest yield in nearly 16 years in late September, at nearly 4.6%.  This marked a dramatic increase from its yield of 3.75% at the end of June 2023. 
  • The surge in Treasury yields came in reaction to the Federal Reserve’s latest statement that interest rates may need to stay higher for longer to bring inflation back to its target rate of 2%.  This resolve to quell inflation disappointed investors, who had hoped for a quick pivot by the Fed to cut rates in late 2023, after it paused rate hikes in June and September.
  • Looking ahead into 2024, investors are currently expecting a half-point reduction in the fed funds rate by late next year, down from the one-point cut anticipated by many earlier in the summer. 
  • The U.S. economy has remained remarkably resilient during the Fed’s rapid rate-hiking campaign over the last 18 months.  Bolstered by a still-robust labor market, solid consumer spending, and-better-than expected corporate earnings, the U.S. economy has so far averted the long-awaited recession that many had predicted for 2023.
  • U.S. GDP growth – a key measure of the health of the overall economy – was a solid 2.1% in the second quarter ended June 30th and is now predicted by the Atlanta Fed’s GDPNow model to top 3.5% for the third quarter. 
  • The labor market also remains seemingly bulletproof.  U.S. businesses have added more than 200,000 jobs in each of the last three months, including September’s blow-out number of 336,000 new non-farm payrolls, a massive surprise to the upside from the consensus estimate of 170,000. 
  • However, inflation remains elevated in the U.S., despite dropping significantly from its recent highpoint in June 2022.  The Consumer Price Index, or CPI, which is the broadest measure of inflation, held steady at 3.7% in September, but remained above July’s 3.3% rate for the second month in a row. 
  • S&P 500 earnings are also projected to be flat year-over-year in Q3, after three straight quarters of declines for the index.
  • Global growth has also faltered, with both China and the eurozone facing sputtering economies.
  • Given all these uncertainties, our outlook for the economy and markets is mixed. We remain cautiously optimistic on equities but are concerned about the lack of corporate earnings growth this year. 
  • Longer term, our outlook for earnings growth and the markets remains positive due to several structural tailwinds, including ongoing technological advancements, increasing worker productivity, widening consumer demand globally, as well as breakthroughs in the biotech and healthcare industries.
  • In terms of portfolio implications, the market’srecent re-pricing in September and early October has presented some new pockets of opportunity, which we are actively evaluating. The write-up of Schwab in this report is an example of such an opportunity which we identified earlier this year.
  • In the meantime, we are still favoring short-term Treasury bonds and money market funds at better than 5% annualized yields for client cash.

The Edgemoor Team

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Markets Continued Their Upward March

In this latest installment of our newsletter, we share our observations of the markets and the economy in the second quarter of 2023. Click here to go to the full report on our website.  Following are the highlights:

  • Stock and bond markets continued their upward march in the second quarter ended on June 30, 2023, adding to gains posted in the first quarter and defying expectations by many for weaker market returns at the start of the year.
  • The S&P 500 Index posted an 8.7% total return in Q2, putting the broad stock market index up 16.9% for the year-to-date period. The Bloomberg Barclay’s Aggregate Bond Index, which was slightly negative in the second quarter, is still up 2.1% so far this year.
  • The strong performance of stocks sent the S&P 500 Index into a technical bull market, defined as a 20% rise off its October 2022 low, and marked the end of the bear market that began in January 2022.
  • Overall, the U.S. economy remains steady, with the labor market strong, inflation easing, consumer confidence rising, and economic growth still positive.
  • Employers added 209,000 jobs in June and the unemployment rate remained low at 3.6%. Inflation continued to ease in June, with the CPI up just 3% year-over-year, a significant slowdown from its high point of 9.1% in June of 2022. Consumer confidence jumped to a 17-month high in June, reflecting the slowdown in inflation and fewer worries about a recession. GDP growth is currently estimated to be 1.8% in the second quarter, down slightly from the revised 2% growth rate in the first quarter, but still positive.
  • That said, some signs of slowdown are emerging. Jobless claims started to tick up in May, though they made an unexpected drop in mid-June. While the services sector continues to expand modestly, the manufacturing sector has remained in contractionary territory for eight consecutive months. And overall inflation remains above the Fed’s 2% target rate.
  • The U.S. Federal Reserve held interest rates steady at its June meeting, maintaining its Fed funds policy target of 5.0% – 5.25% and putting its aggressive rate hikes over the last fifteen months on what some termed a “Hawkish Hold.” This means that despite the pause, the Fed expects stronger growth and persistent inflation in the months ahead, which will likely mean additional rate hikes before year-end.
  • Looking ahead, the spotlight is now on corporate earnings and overall market liquidity as major factors in determining the course of the U.S. economy and markets in the second half of 2023.
  • Given all these uncertainties, our outlook for the economy and markets is mixed.
  • We remain cautious on equities in the near term, though our longer-term outlook is positive. The 12-month forward price/earnings ratio (P/E) for the S&P 500 Index is 19 times, which is above both the 5-year and the 10-year averages.
  • In addition, this year’s equity market rally has been largely concentrated in just seven high-flying technology stocks, including many we own, namely Apple, Amazon, Microsoft, and Google. A narrow market like this tends not to have the longevity of a more broad-based rally, causing some concern for investors.
  • And although aggressive rate hikes may be behind us, we expect to remain in a higher-for-longer interest rate environment until inflation cools and the labor market softens.
  • We continue to look for and find some pockets of opportunity in today’s market (see our new investment write-up on Thermo-Fisher Scientific in the final section of this report). In addition, we continue to deploy uninvested cash in short-term Treasuries and money market funds at attractive, low risk, annualized yields at or above 5%.
  • We believe that our patient, disciplined approach to active security selection gives our clients better long-term return potential in a cost effective and tax efficient manner.

The Edgemoor Team

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Markets Prove Resilient Though Volatility Continues

In this latest installment of our newsletter, we share our observations of the markets and the economy in the first quarter of 2023. Click here to go to the full report on our website.  Following are the highlights:

  •  Stock and bond markets proved far more resilient in the first quarter of 2023 than most investors expected, though it was not without considerable choppiness along the way.
  • The S&P 500 Index posted a surprisingly strong 7.5% total return in the first quarter of 2023, while the tech-heavy Nasdaq saw an even better recovery from last year’s losses, returning 17% for the quarter, its best quarter since the second quarter of 2020.
  • The Bloomberg Aggregate Bond Index also returned a positive 3.0% in the first quarter, as long-term interest rates declined, sending bond prices higher.  The yield on the 10-year Treasury note, which influences everything from mortgage rates to car loans, fell to 3.5% by quarter-end from 3.8% at the end of 2022.
  • The shock to the banking system by the sudden collapse of SVB in mid-March sent some financial stocks down 30% or more for the month, though the contagion hit mostly smaller, regional banks while larger, money-center banks fared much better. For the quarter, the S&P Regional Banking ETF was down 25%, while the broader Financial Sector ETF was off just 6.5%.
  • The heightened risk to the financial system from the bank failures likely impacted the Fed’s decision to raise short-term interest rates by just 0.25% in March, despite an expected increase of 0.50% earlier in the month. The Fed also softened its language regarding future rate increases by omitting a prior forecast for “ongoing increases.” This has raised hope among investors that the Fed may be ready to pause its rate raising campaign, despite the persistence of inflation.
  • Notwithstanding the persistence of high inflation and slowing economic growth, there has been some positive economic data so far in 2023. The Atlanta Fed projects first quarter GDP growth of 2.2%, which, while down from fourth quarter GDP growth of 2.6%, nonetheless indicates a growing economy.
  • The labor market also remains robust, although slowing. The U.S. economy added 236,000 new jobs in March, roughly in line with expectations. The unemployment rate slipped to 3.5% in March from 3.6% in February, and the labor force participation rate continued to rise, which is considered a positive. The U.S. has added more than one million new jobs in the first three months of this year.
  • But recession fears are rising. The Fed recently lowered its forecast for full-year 2023 GDP growth to just 0.4%. Given that estimates for Q1 GDP growth are in the range of 1.5%-2.5%, this suggests that the U.S. could see negative GDP growth in the coming quarters. Recession is generally defined as two consecutive quarters of negative GDP growth.
  • Finally, corporate earnings are contracting. S&P 500 earnings declined 4.6% in the fourth quarter of 2022 and are forecasted to decline again in the first quarter of 2023.
  • Still, some argue that a recession is not inevitable. Those in that camp point out that inflation appears to have peaked, supply-chain woes have eased, China has re-opened its economy, and oil prices remain low. We’ll see who is right.
  • Given all the uncertainties, our outlook for the economy and markets is mixed.  We remain cautious on equities in the near term. Stock valuations, as measured by the S&P 500 Index, are neither overly expensive, nor are they cheap. We expect market volatility to remain elevated until there is more clarity on interest rates, inflation, corporate earnings, and world economic growth.
  • While we are maintaining our long-term, value-oriented investment philosophy, we have taken a more cautious view of equity markets for the near term. Instead, beginning last fall, we have been deploying uninvested cash in short-term U.S. Treasuries at attractive, low-risk annualized yields of 4.5% – 5%.
  • Once the Fed signals that it is pulling back from its aggressive rate tightening, and economic growth and corporate profits have stabilized, we will resume deploying cash in long-term equities.
  • We continue to believe that our disciplined, active approach to individual security selection is more cost effective, tax efficient, and offers better long-term return potential over a full market cycle for our clients.

The Edgemoor Team

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Good Riddance to 2022!

In this latest installment of our newsletter, we share our observations on 2022 and our outlook for 2023. Click here to go to the full report on our website.  Following are the highlights:

  • Good Riddance to 2022!
  • Most investors were happy to see 2022 come to an end.  There were few places for investors to hide, as nearly every segment of the financial markets posted losses for the year. U.S. stocks posted their worst year since 2008, while many parts of the bond market suffered their biggest losses in history.
  • The traditional role of income investments as a buffer to more volatile equity markets did not hold up, deepening the pain of balanced portfolios.
  • The S&P 500 posted a negative total return for the year of 18.1%, just shy of bear market territory (a decline of 20% or more), where it had spent much of the year. 
  • Bonds had their worst year in history, with the Bloomberg Barclay’s Aggregate Bond Index posting a 13% decline for the year.  Prior year losses going back to 1976 had never exceeded negative 2% for the bond index.
  • Global diversification didn’t help investors either, as both the European and emerging markets indices experienced double-digit losses.
  • And in perhaps the most spectacular crash of the year, cryptocurrencies spent most of the year in severe decline, capped off by the collapse of crypto trading platform FTX in November.  The largest cryptocurrency, bitcoin, lost over $550 billion in market value in 2022 as its price sank 65%. 
  • The market’s heightened volatility was directly related to larger-than-expected increases in inflation and interest rates throughout the year.
  • U.S. inflation hit a decades-high rate of over 9% in June 2022, spurring the Federal Reserve to raise its benchmark Fed Funds rate at its fastest pace since the early 1980s.  The Fed’s seven interest rate hikes through the year resulted in the short-term rate rising sharply to a target range of 4.25% – 4.5% at year-end from near zero in January. 
  • Looking ahead, the good news is that the worst of the rate hikes is likely behind us, as the Fed is expected to slow its pace of rate increases in 2023.  At its next meeting in February, many expect the Fed to raise rates by just 0.25% and end 2023 with an expected Fed Funds rate of around 5%.
  • Recession or Slow-cession?  Rising interest rates are intended to slow the economy just enough to dampen inflation.  But a recent WSJ survey indicated that economists place roughly 65% odds on the U.S. economy slowing enough to fall into some level of recession in 2023.  The depth and length of a potential recession, however, remain hotly debated.   
  • In fact, several economists believe that 2023 might not bring a full-blown recession at all, but rather a “slow-cession” – or a period of less than 1% GDP growth in each of the next four quarters.  They point to the strong labor market, healthy consumer and corporate balance sheets, and a well-capitalized financial system as reasons why the U.S. economy could avoid a significant economic contraction this year.
  • Declining inflation is another potential bright spot for the U.S. economy in 2023.  The Consumer Price Index, or CPI, which is the broadest measure of inflation, hit a highpoint of 9.1% in June 2022 and has since declined steadily to its latest reading of 6.5% in December, which was the smallest 12-month increase since December 2021.
  • Outlook for 2023:  Our outlook for the stock market and the economy in 2023 is somewhat mixed.  While we do expect inflation and interest rates to moderate in 2023, their negative impact on corporate earnings and the job market is likely to become more pronounced in the first part of the year. 
  • While we are maintaining our long-term, value-oriented investment philosophy, we have taken a more cautious view of equity markets for the near-term.  Instead, we have been deploying cash in short-term U.S. Treasuries at attractive, risk-free yields in excess of 4.5%. 
  • Stock valuations have started 2023 at more reasonable levels than at the beginning of 2022.  The forward 12-month price/earnings ratio for the S&P 500 currently stands at 17.3 times, below the 5-year average of 18.3 times and well below the 23x valuation at the beginning of 2022.  We believe this should translate into better compounded returns for investors over the next 2 – 5 years once the economy and markets stabilize.

The Edgemoor Team

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