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Economic Update Q4 2023

Economic Insights and Festive Wishes: Navigating 2023's Twists and preparing for 2024

As we welcome the holiday season and wave goodbye to the twists of 2023, a year defined by market ups and downs, the Markets have embraced their lowest levels of volatility since the pandemic's beginning, suggesting a certain measure of stability. Yet, investors remain watchful, mindful of potential challenges like geopolitical tensions, upcoming elections, and the constant prospect of economic surprises. In this economic update, we'll delve into these areas, illuminating the pivotal events of the year that will influence our investment approach for 2024.

Market Performance

Both the stock and bond markets have shown positive trends, responding favorably to encouraging economic data, however, caution is recommended due to underlying risks. Monthly fluctuations and persistent inflation, particularly in the services sector, are reminders that challenges persist. Despite a decrease in the inflation rate to 3.2% in October, Federal Reserve Chair Jerome Powell emphasizes readiness to raise rates if necessary.

Since the beginning of 2023, the S&P 500 has yielded a return exceeding 19%. This index is market cap-weighted, with larger companies holding a greater influence. In contrast, we highly recommend and use an equal-weight version of the same index, where each company holds an equal share regardless of size. This index has only gained approximately 6% over the same period. The substantial upward trajectory in U.S. equities this year can be attributed primarily to three technology-related sectors and the enthusiasm surrounding generative AI (artificial intelligence), termed the "Magnificent Seven." Given this remarkable outperformance in a relatively brief period, investors are advised to consider tempering their expectations for continued mega-cap dominance and adhere to a long-term investment strategy.

Interest Rate Trends

The U.S. 10-year bond yield reached 5.00% on October 19th but has since decreased closer to 4%. This shift is influenced by several factors, including a lower-than-expected inflation in October and the ongoing decline in oil prices, fostering hopes of a soft economic landing. While the partial retreat of these yields lessens the impact on economic growth, it's crucial to note that this doesn't indicate an imminent end to recession risk. The future direction of yields hinges on two key factors: (1) the expected trajectory of the Fed's policy rate and (2) the term premium for fixed payments (extra yield or interest rate compensation that investors typically demand for holding a long-term bond instead of a series of shorter-term bonds). The policy path depends on whether the economy demonstrates that higher interest rates effectively contribute to dramatically lowering employment gains, a crucial condition for sustaining inflation at 2%.

Stock Market Dynamics

Value stocks faced headwinds this year, due to sustained higher interest rates, prompting investors to favor the bond market for comparable risk. The dynamic of rapid growth and low interest rates following the COVID-19 pandemic favored growth companies over value in the short term. While value stocks have regained some ground in recent months, they still lag significantly behind growth stocks post the "Magnificent Seven" (Apple, Amazon, Alphabet, Nvidia, Meta, Microsoft and Tesla) rally. Noteworthy gains among value stocks in the second half of the year have been led by sectors such as financial services, healthcare, energy, and technology.

Household Savings Impact

The excess savings resulting from the pandemic originated from three rounds of fiscal stimulus implemented as emergency measures. The initial two rounds were implemented under the Trump administration, while the third, notably extensive round, was endorsed by President Biden. According to the latest Federal Reserve study on household finances, individuals outside the top 20% income bracket have depleted their extra savings and currently hold less cash than they possessed at the start of the pandemic. For that bottom 80% of households, after adjusting for inflation, bank deposits and other liquid assets in June this year were lower than their levels in March 2020.

Geopolitical Developments

A year and a half after Russia's invasion of Ukraine, recent geopolitical events have brought uncertainty to the forefront. Following Hamas' unexpected attack on Israel and the subsequent invasion of the Gaza Strip by the Israel Defense Forces, concerns about potential escalation are uncomfortably high. While the conflict in Israel and Gaza has been heart-wrenching, its economic impact on the global economy has, so far, been limited. Geopolitical instability in the region typically affects the global economy through oil markets and the most significant risk lies in the potential involvement of Iran in the conflict, raising questions about global energy supply.

China's Economic Landscape

China's GDP grew by 4.9% in July-September, surpassing analysts' expectations of a 4.4% increase but slower than the 6.3% expansion in the second quarter. In October, the country's credit growth remained stable, with a notable rise in government bond sales to fund stimulus efforts compensating for weak business and household borrowing. The real estate sector continues to impede Chinese growth, with real estate investment remaining 9.1% below 2022 levels. The housing market slump, coupled with low corporate confidence, has led to a relatively sluggish credit expansion this year.

Outlook for 2024

As we approach the holiday season, we extend heartfelt wishes to all our clients. Looking ahead, we anticipate a positive finish for the stock market by year-end. However, the initial six months of 2024 may bring challenges, including potentially stagnant earnings growth and the lingering impact of elevated interest rates. Our focus will be on closely monitoring the housing market, the bond market and the dollar, actively seeking promising opportunities for stock investments. With over 35 years of combined experience in wealth management, navigating various market cycles, our team excels in making strategic investment decisions that optimize value and provide robust safeguards against potential downturns. In conclusion, we wish you a delightful holiday season filled with joy, laughter, and the warmth of cherished moments with your loved ones.

The particulars contained herein were obtained from sources we believe to be reliable, but are not guaranteed by us and may be incomplete. The opinions expressed are based upon our analysis and interpretation of these particulars and are not to be construed as a solicitation or offer to buy or sell the securities mentioned herein. The opinions expressed do not necessarily reflect those of NBF. I have prepared this report to the best of my judgment and professional experience to give you my thoughts on various financial aspects and considerations. The securities or sectors mentioned in this letter are not suitable for all types of investors and should not be considered as recommendations. Please consult your investment advisor to verify whether the security or sector is suitable for you and to obtain complete information, including the main risk factors. Some of the securities or sectors mentioned may not be followed by the analysts of NBF.

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