Welcome to the new year! A perfect time to reflect on the year prior, lessons learned and think about our hopes and expectations for 2024.

Every year we get older (but better looking, of course!) and hopefully wiser. When it comes to the wiser part, that generally means learning from mistakes of the past. We know not to touch hot stoves or agitate strange dogs but when it comes to investing, there are common mistakes that investors repeat over and over.

Some of you may be amused to learn that bell-bottom jeans came back into fashion in 2023. Let’s consider some investment highlights from this past year to remind us that, unlike flared denim from the 70’s, good investment habits never go out of style.

The Importance of Staying Invested

Let’s rewind back to October 2023. Investors were frustrated and feeling impatient - a diversified portfolio was essentially flat for the year, which would not be so bad if it weren’t for 2022 being a very challenging year too.

Yet from October 28th through the end of 2023, the market experienced a huge and broad-based rally. Tech stocks continued to show strength but previously unloved asset classes such as small companies, real estate and bonds really took off. A typical diversified portfolio ended the year 10%+[1]. In other words, over a year’s worth of returns in just 6 weeks! An investor that got spooked or stayed on the sidelines in the summer or fall, would have missed out on all the gains 2023 had to offer.

The lesson is that the market can snap up or down at any moment and you’re unlikely to catch either just right or with any consistency. Missing out just a few key days in the market can result in tremendous underperformance against the benchmark.

The Illusion of Cash

A few years ago, the typical savings account was paying a paltry interest rate of 0.1%. The US Federal Reserve, which controls interest rates, was encouraging people to invest by making cash unattractive. And invest people did, driving the market to a frenzied high in November 2021. This low interest rate environment set the stage for inflation causing the Fed to then run in the other direction. From February 2022 to August 2023 the effective federal funds rate went from .08% to 5.33%[2].

With higher rates punishing investors (because no one likes higher borrowing costs), by mid-2023, investors began asking the question, “why take the risk of investing in the market when I can get a ‘risk-free’ return of 5%+”? Then in October, the inevitable happened. The Fed signaled that it might be done raising interest rates and might even start lowering them in 2024. The market cheered to the tune of a 15% bounce from the end of October through the end of the year – 3 years’ worth of cash yield in just over two months. With the potential for lower rates, the prospects for 2024 also brightened and the allure of cash dimmed further. It’s quite possible that with continued falling inflation, interest on savings next year could be closer to 4% and potential market gains will continue to leave cash in the dust.

Cash is important for financial flexibility and as a safety net. As part of core financial planning, we discuss maintaining a healthy cash reserve. Over the long haul, however cash has underperformed stocks by an extraordinary margin. Cash should not be thought of as a long-term investment and often the best time to invest in stocks is when the appeal of cash is at its highest.

Politics Matter Less than People Think

This last year, there was worry that Congress would not pass a spending bill in time and the US Government would default, creating a cascade of financial damage. Despite the bickering, multiple spending bills were passed, just like in most other years. The one year where congressional gridlock did cause the government to shut down for 3 weeks (2013), the impact on the market was negligible.

We are also coming into an election cycle. You will soon be hearing pundits attempt to link politicians and their policies to investment performance, but don't fall for it. First, history shows that the markets prefer government gridlock[3]. Investors see action by either party as mostly damaging so they prefer the stability of a contested government than one that can make drastic changes. Vanguard analyzed date since 1860 and found no statistical relationship between performance or increased volatility of a balanced portfolio and election cycles[4].

Predictions for the Year Ahead are Often Wrong

A year ago, sentiment on Wall Street was gloomy. The market had lost 20% in 2022, inflation was still sky-high, high borrowing costs were crippling business activity and the war in Ukraine kept the geopolitical mood sour. Expectations for the year ahead were for more stock market losses. Despite these expectations, the stock market ended 2023 up by 24%, driven primarily by a handful of tech stocks. Another year, another lesson of why it’s best to avoid trying to predict the market.

Take this away from this past year: most market gyrations are overreactions and logic will prevail over your gut over the long haul. 2023 was yet another year where investment lessons long known had to be learned once again. How do we become better investors? By applying them to the year ahead…

It’s Hard to Have a Recession When the Job Market is Strong

Some are still predicting a recession is imminent in 2024 but as we said in our newsletters several times last year, it’s hard to have a recession when people are working and spending money.

American consumers are the grease of our economic engine. Their ability and willingness to spend are pivotal to economic growth, especially in the near term. Right now, we have low unemployment and wage gains are currently outpacing inflation, partially because of a significant imbalance of job openings vs. unemployment. This could potentially create a just right scenario for the economy for the time being.

Let’s Continue to Avoid Bubbles

They say that the stock market is driven by fear and greed. The past year was no exception and led to quirky outcomes. Consider the performance of the 500 largest public companies in the US throughout 2023:

Top 7 stocks returned 75%
The bottom 493 stocks returned 12%[5]

These 7 stocks benefited greatly from speculation around tech and Artificial Intelligence. To us, however, enthusiasm for AI looks very similar to bubbles of the past (see chart below)[6].

While your portfolio certainly owns some of the frothy names, like Amazon and Apple, we also own many other things such as foreign stocks, small companies, real estate, and companies that have not ridden this speculative wave. It’s important to remember that like eating vegetables, diversification is good for you in the long run, smoothing out returns, avoiding froth and reducing risk.

Conclusion

Unlike at the beginning of 2023, today’s market sentiment is generally optimistic for the year ahead. The job market is strong, inflation is falling, and the Fed is considering lowering borrowing costs later in the year. Consumers continue to spend and although debt levels are rising, it’s not at dangerous levels yet. We continue to see weakness overseas but perhaps this may be the year that Europe and China finally turn a corner.

While we would not bet against this economy, the lessons mentioned above suggest that reality often confounds expectations. Whether the market goes up this year or down, our goal will be to help you stay the course and retain these lessons at exactly the moment that they seem the most counter-intuitive. The most successful investors do make mistakes, but rarely do so twice.

[1] https://fortune.com/2023/11/25/investing-advice-60-40-portfolio-starting-point-financial-advisors/

[2] https://fred.stlouisfed.org/series/FEDFUNDS

[3] https://financialpost.com/sponsored/fisher-investments/why-markets-like-political-gridlock-according-to-fisher-investments-canada

[4] https://investor.vanguard.com/investor-resources-education/article/presidential-elections-matter-but-not-so-much-when-it-comes-to-your-investments

[5] Goldman Sachs Global Investment Research: https://www.dailymail.co.uk/yourmoney/savings/article-12877353/magnificent-seven-stocks-tech-ai-2023.html

[6] https://finance.yahoo.com/news/chart-day-magnificent-7-stocks-233626055.html#:~:text=The%20Magnificent%20Seven%20stocks%20have,Japan%2C%20and%20Canada's%20stock%20market.

Diversification does not assure a profit or protect against loss in declining markets, and diversification cannot guarantee that any objective or goal will be achieved.

Auld Lang Syne: Investing Lessons for 2024