In 2023, investors faced headwinds including elevated inflation, geopolitical tensions, rising interest rates, and growing concerns over a potential recession that never materialized.
Amidst these challenges, resiliency prevailed in many forms. Unemployment remained low, consumer spending strong, and corporate profits continued to beat expectations. Two positive themes that emerged were: enthusiasm around the prospects for artificial intelligence and, despite continued concerns over stubborn inflationary pressures, prices began to ease through the year. This resiliency, among other positive developments, helped to push markets higher with the S&P 500 ending the year up over 25% and the broad fixed income market overcoming an otherwise challenging year to generate a return of more than 5%.
Looking ahead in 2024, a key focus for markets will be on the policy actions of the Federal Reserve (Fed). Among the key factors driving Fed policy will be inflation and labor market dynamics. Regarding inflation, we expect price growth to continue moderating through the year as rents and used car prices soften. We also expect to see some cooling in the labor market, creating a better balance between the supply and demand for jobs.
We expect that the Fed will keep its key policy rate (the federal funds rate) in the 5.25% to 5.50% range for the next two quarters, before shifting to rate cuts in the second half of the year. However, we believe investors should focus more on the broader direction of rates over the next 12 to 24 months, rather than the specific timing of the first cut. Currently our view is that rates will be lower by year end and will continue to move lower through 2025.
From an economic perspective, the cumulative impact of past rate hikes will continue to weigh on the consumer and corporations, which in turn will pressure growth. TD Wealth® expects positive, but sub-trend economic growth over the next two quarters, followed by an uptick in the second half of the year. Although unemployment is expected to rise from current low levels, we expect to see continued resilience in the labor market.
Given this outlook, TD Wealth® is more constructive on fixed income; however, we also see opportunities in equities. Fixed income investors continue to receive higher levels of interest income and have the potential for capital appreciation once interest rates move lower in the second half of the year. We see potential in higher quality subclasses such as short-term bonds, intermediate Treasuries, agency mortgage-backed securities and municipal bonds.
Within equities, we believe that being selective and focusing on high quality may be the more prudent course. We prefer U.S. stocks over international equities as the U.S. is relatively more sheltered from current geopolitical risks compared to regions such as Europe and Asia. The Fed is also further along in their policy path than other global developed central banks, which is likely to uplift growth.
Importantly, we believe investors should work with an experienced team of advisors to develop a comprehensive financial plan, invest in a portfolio designed to help execute that plan, and remain invested in that plan over the long term. 2023 serves as a reminder that while market volatility can be uncomfortable, investors should never let short-term market fluctuations drive decision making. Staying invested and focusing on your long-term goals may help your chances of success.
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