Capital markets perspective: Round trip

Capital markets perspective: Round trip


In the spirit of New Year’s reflection, I decided to pause, breathe deep, look back at how 2023 began for markets and the economy and compare it to where we sit today.

Coincidentally, the yield on the 10-year U.S. treasury note provides a convenient point of entry: After poking its head briefly above 5% – a level it hadn’t hit since George W. Bush was President and Bob Barker was still hosting Price is Right – the 10-year note finished 2023 almost exactly where it started. Of course, that fact ignores a whole lot of volatility in the interim. But it’s still the kind of oddity that grabs your attention, especially given how much transpired in 2023.

But did it really? When you look backwards with a dispassionate eye, it’s fair to wonder if things really have changed at all since 2023 began. Here’s a short list of things that feel pretty much the same today as they did 12 months ago.

First up, economic growth. Last December, the economy was growing at a reasonable clip and the labor market was tight. Both are still true today – according to the latest data available, gross domestic product expanded by 4.9% in the third quarter and the unemployment rate still starts with a “3.”

Meanwhile, the yield curve started 2023 upside-down and flashing recessionary warnings as the year began, something that is still objectively true today. At the same time, the Fed was shrinking its balance sheet in a very disciplined way via “quantitative tightening.” 

I could go on. For example, we could talk about the dominance of a small group of fast-growing stocks that have prospered while others mostly treaded water, or housing, or the durability of the U.S. consumer and the fact that the manufacturing sector is clearly in contraction while services-oriented businesses are mostly holding their own. These things are all eerily similar today when compared to where they were the last time we all undertook our annual exercise of year-end reflections.

But as is usually true for markets, it’s the differences that deserve the most attention. And while it’s a shorter list, some of the items on it are profoundly significant. Take, for example, inflation. In perhaps the best news of 2023, inflation has slowed, with core consumer price inflation ending the year at 4.3%. Inflation, like virtually every economic variable known to economists, never moves in a straight line and it’s still possible to imagine all sorts of scenarios where inflation rears its head again, but an obvious cooling price growth nonetheless led to the second big difference between today and last December – a friendlier Fed. With a surprising change in tone, Fed Chair Jerome Powell pivoted in mid-December during the last regularly scheduled FOMC meeting of the year, removing his voice from the group still warning that it might be premature to get too excited about rate cuts for 2024.

It's tempting to draw a straight line between Powell’s perspective and the last entry on our list of important things that have changed since 2023 – namely, equity market valuations – but that would be incorrect. Remember, Powell’s change-of-heart occurred with only two weeks to go in 2023, while the valuation/PE-driven market rally was in place pretty much on day one. Whether that was in anticipation of Powell’s pivot is mostly an academic question, but know this: Valuations started the year near or even slightly below longer-term averages, but rose steadily throughout the year and are now looking a little stretched, particularly in areas where equity market optimism has been the highest.

So the more things change, the more they stay the same. Or so the saying goes. But I for one just can’t shake the feeling that all this apparent sameness between today and a year ago is more a symptom of reckoning delayed rather than side-stepped entirely.

That seems like a great place to close, but it unfortunately leaves out any mention at all of last week’s macroeconomic developments, scant as they are. For example, I could tell you that last week’s data again reinforced the manufacturing sector’s renewed descent into contraction (see regional manufacturing reports from the Dallas,1 Richmond,2 and Chicago3 branches of the Federal Reserve for details), or how home prices continued to grow4 even as home sales volumes remained flat.5 

Indeed, last week’s data was mostly as expected; links are included in the footnotes.  

What to watch this week

After enjoying two quiet weeks and a pair of three-day weekends, 2024 starts off with a bang as we get non-farm payrolls and all that comes along with it. Friday’s payroll release will include estimates of the number of jobs created by the U.S. economy in December, the unemployment rate, labor force participation and average hourly earnings. Prior to that we’ll get a fresh look at the number of job openings (the so-called JOLTS report on Wednesday) and the final tally of layoff announcements for 2023 as catalogued by Challenger, Gray & Christmas. Payroll processor ADP will issue its own estimates of December job creation on Thursday, in conjunction with its aptly named “pay insights” data, which provides granular detail regarding pay trends across various segments of the U.S. economy.

Payrolls week is always important for markets, but never more so than today. Throughout 2023, labor markets were one of the keys to Fed policy and therefore highly relevant to the overriding market narrative. That’s still true today: If labor market tightness in turn creates the kind of wage inflation that threatens to re-ignite inflation, the Fed may become far more active than it is today. But the other side of the fence – unexpected and/or severe weakness in the labor market – is also a risk in 2024 because the ability of the labor market to endure more than 5% worth of Fed tightening without tipping over in a big way is the very definition of the “soft landing." Said differently, the U.S. labor market has a very narrow path to walk if it’s to avoid perturbing markets in 2024, and this week will be its first tentative steps along that tightrope.

Next on the list of what could prove important this week are the full set of purchasing manager’s indices, including manufacturing on Wednesday and services on Thursday. As discussed many times before, the manufacturing sector’s weakness has recently been on full display – first in a renewed decline in PMI data and second in continued weakness (and sharp volatility) in regional Fed manufacturing reports like Empire State, Philly Fed and various others. For 2024, the focus will shift more intensively toward the services sector, which so far has been more durable. If weakness begins to show up in services-related PMIs in more durable fashion, it will become harder and harder to keep the economy out of recession and defend the soft-landing narrative.

Finally, we’ll get minutes from the Fed’s December meeting on Wednesday. That meeting was host to Powell’s pivot, making Wednesday’s release important in understanding the context. At the same time, December’s meeting included the economic views of the Fed’s own economists, commonly referred to as the “staff economic projections,” or SEP for short. The most famous component of the SEP is the so-called “dot plot,” which details how each FOMC participant thinks rates will evolve in the future. The latest edition of the dot plot aligned a little more closely with the market’s view that the Fed would cut as many as six times in 2024, but still left a reasonably wide gap between market expectations and those of policymakers themselves. Any detail in the official notes of the December 15 meeting that hints about the future direction of that gap could prove very important to markets as we step into the new year.

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Tom Nun, CFA


Tom Nun, CFA, Portfolio Strategist at Empower, works alongside teams overseeing portfolio construction, advice solutions, portfolio management, and investment products and consulting.

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