By Nick Skillman, CFA®
2023’s Economic Challenges and Tightening Measures
Entering 2023, inflation was at center stage for the Fed and investors, exceeding 6% on a year-over-year basis. The Fed was aggressively hiking rates at a 75 bp clip, causing the market, with technology in particular, to trade near cycle lows. A looming recession was the consensus, and positioning across asset classes reflected such. Throughout the year, bouts of market volatility ensued, stemming from negative liquidity impulses from the likes of the Fed’s tightening policy and U.S. Treasury’s outsized duration issuance. These actions led up to the regional banking crisis and a violent increase in interest rates across the Treasury curve, adversely impacting asset prices enough to ultimately require stabilizing measures being undertaken.
Beyond these events, the year’s price action was largely driven by a favorable regime, one where growth remained elevated, consistently surprising to the upside, and inflation declined significantly. The strength in economic activity can be attributed to the resilience in employment, fiscal deficit spending, and the broader cyclical trend of deglobalization and onshoring. This occurred amid a restrictive Federal Reserve, maintaining rate hikes through August and reducing the balance sheet through Quantitative Tightening.
Economic Growth and the Fed’s Shift
Looking ahead to 2024, the positive trends in economic growth and inflation continue to play out, however, now with the added benefit of an accommodative Federal Reserve. In December, the Fed surprised markets by effectively ending its hiking cycle and, more recently, introduced the notion of a slowdown in the pace of balance sheet reduction. This combination of factors has greatly reduced the risk of recession in the intermediate term and should prove favorable for risk assets moving forward, as long as growth is sustained and inflation remains stable.
However, similar to how the bear steepening of the yield curve in September-October finished the job of tightening financial conditions for the Fed, eliminating the need for further rate hikes, a scenario exists where the post-Powell pivot response from the long end of the yield curve, the dollar, and commodities will loosen financial conditions enough to reignite inflation risk. This could prompt the Fed to revert back to their higher-for-longer narrative. If we begin to see material upticks in break-even rates and inflation swap rates, the favorable regime we’re currently experiencing would likely be challenged.
Although this is likely not a concern in the near term, a more probable outcome is we see a repricing in the rates market, which is currently pricing in six rate cuts for 2024, starting in March. This type of policy action would need to be preceded by a significant deterioration in growth, which seems unlikely given the strength we’re seeing from the broader economy and employment. Our view is that the market has overshot itself in terms of timing of future rate cuts, and any recalibration could act as a catalyst, temporarily challenging the current rally in both equities and bonds.
Investment Strategy for 2024: A Risk-On Approach
In terms of investment strategy for 2024, the general theme should be risk-on given the preconditions for growth, employment, inflation, and liquidity. The most recent Quarterly Refunding Announcement and FOMC Meeting provided some much-needed stability in both rates and the dollar, effectively putting in a cyclical top for both, which should further support risk assets. Similar to how 2023 played out, the laggards are likely to outperform, as breadth continues to improve and investors rotate out of crowded trades. This would equate to sectors such as energy, materials, and financials outperforming over the coming year, benefiting from a weakening in yields and the dollar.
We remain overweight financials and anticipate a strong rebound in 2024 following the Fed’s pivot. Net interest income will benefit from any re-steepening of the yield curve, and the easing of financial conditions should take pressure off loan books. We retain the philosophy of investing capital in large-cap banking institutions, which we view as prudently run with a focus on long-term success. We used the weakness in financials in 2023 as an opportunity to add to our preferred stock portfolio, allocating to names where balance sheet risk was mispriced, picking up yields in the 7-8% range. The stability in rates should provide additional support for our investments in the preferred stock of these large-cap banks.
Sector Potential & Outlook
Similar to how technology outperformed in 2023 after coming into the year with extreme underweight readings, the energy sector is set up perfectly to repeat this idea. Investors have priced energy stocks for a hard landing, with net positioning currently at 2020 levels, when the global economy was shut down and oil was trading below zero. We can’t help but compare that to the economic landscape we see currently, where GDP is printing above 5%, unemployment is below 4%, and the Fed is communicating rate cuts. The sector is poised to benefit from this current economic regime, and should further be supported by investors’ need to rebalance as recession risk gets priced out in the early innings of 2024.
Moreover, geopolitical tension in the Middle East continues to persist, likely setting a floor on the price of oil in the mid-$60 range. Holding exposure to oil-related assets should serve as a secure portfolio hedge amid further escalation. We remain overweight exploration and production companies, who continue to prioritize shareholder returns over riskier long-term investments in production capacity.
Finally, despite the possibility of technology underperformance in 2024, large-cap industry leaders should continue to provide safe-haven status for investors. The boom in artificial intelligence sparked widespread investment in 2023, however, we’re likely to witness a separation of the true beneficiaries from the crowd over the coming years. Microsoft and Google, with their proven track records and strategic positioning, stand out as prime candidates to distance themselves in this evolving landscape. Whether this trend begins in 2024 remains to be seen, but our investment approach remains directed toward capturing the value from longer-term technological innovation.
Partner With a Professional
As is true with most things in life, choosing the right securities to invest in takes careful research and experience. There are many ways to make more money, but some are less risky than others. At Fogel Capital Management, we take a detailed approach to analyzing every client’s unique financial situation.
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About Nick Skillman
Vice President, Portfolio Management
Nick joined Fogel Capital Management in the spring of 2019, after graduating from the University of Florida with his Bachelor’s Degree in Finance. He serves a variety of roles on the investment team, of which include assisting Fogel Capital’s Head of Trading in the management of client accounts, conducting extensive capital market research, and communicating personalized investment analysis to clients with regards to investment strategy, portfolio construction, individual security selection, and risk exposure. He holds the Series 65 Uniform Investment Advisor License and strives to provide personalized investment advice for each individual client. He has also furthered his knowledge and capabilities in portfolio management and asset valuation through his completion of the Chartered Financial Analyst® Program, where he is an active charter-holder.
Disclosure: Fogel Capital Management, Inc. strives to maintain the accuracy of all data presented in this material. The information provided is intended to disclose data that may not be otherwise known and should not be construed as personalized investment advice. Past performance is not indicative of future results. The data presented in this material is copyrighted by Bloomberg L.P. and is sourced through Bloomberg L.P.’s services. This material is confidential and should not be reproduced without the express consent of Fogel Capital Management, Inc.