What’s New

Christmas came early in December for investors as bond yields continued to fall and equities delivered positive returns to close out a particularly strong year.

The month was largely a continuation of trends that started the previous month, with the market continuing to price in a soft landing for inflation and the economy. By this, we mean a scenario in which the Fed sustainably defeats inflation without causing significant economic pain, and then begins the process of cutting interest rates. The implied outcome is one in which markets can keep moving higher because earnings stay supported by economic growth and multiples can expand on falling rates.

Falling sovereign rates were driven in large part by the market pricing in additional rate cuts during 2024. We entered the month of December with investors pricing in between four and five rate cuts from the Fed and ended the month at six. This would certainly represent a material easing of financial conditions, but we would continue to caution that such an aggressive rate cutting cycle is unlikely against a backdrop of continued economic strength and benign inflationary pressures. To the extent that we did see rate cuts of a similar magnitude, it would likely be in response to a rapid deterioration in economic or financial conditions.

Nevertheless, continued economic strength and easing financial conditions supported not only a move higher in equities, but something of a rotation under the surface. Whereas large cap equities—in particular the Magnificent 7—dominated returns throughout the year, we have started to see small caps play catch-up. Thus, while the S&P 500, Dow Jones Industrial Average, and NASDAQ returned 4.5%, 4.9%, and 5.6%, respectively in December, the Russell 2000 returned a whopping 12.2%. For reference, the Russell 2000 is comprised of much smaller companies and is generally thought of as being more reflective of economic conditions. Sector performance was somewhat reflective of this rotation as well, with sectors including Real Estate, Consumer Discretionary, Financials, and Industrials delivering strong returns during the month (though Health Care—a more traditionally defensive sector—was also a very strong performer).

Moving into the new year, we continue to remain concerned about the balance between risk and reward in equity markets. We find it unlikely that we end up in such a goldilocks scenario whereby the Fed can aggressively cut rates against a backdrop of a strong economy and weak inflation. As such, we continue to be cautious in our positioning while selectively seeking out investment opportunities.

Our Perspective

We have been adamant that a soft landing is unlikely as we progress through the economic cycle. Historical evidence suggests that the Fed has never brought inflation down from the levels we’ve seen without causing significant economic hardship. Should the Fed begin cutting rates aggressively next year, we believe it is more likely than not that it will be in response to an adverse economic outcome or exogenous shock. Earnings would likely be hit hard by the economic slowdown driving the Fed to cut.

Given the above, the market is likely going to have to reprice its outlook with higher yields, rising uncertainties, and weaker earnings. While the market is typically forward-looking, recessions tend not to be priced into the market until their arrival is imminent.

With that in mind, we are placing an emphasis on risk management and have adopted a defensive position strategy in our core portfolios.

How 2023 Set the Stage for 2024

It was once said that there are years where decades happen, and 2023 certainly felt that way

From crises averted to ongoing geopolitical turmoil, falling inflation to a resilient economy, rate hikes to the anticipation of rate cuts, it’s almost easy to forget just how much we saw this year. As 2024 comes into view, let’s take stock of the more important developments we saw through 2023 – and what they could mean moving forward. Read the five influences in, How 2023 Set the Stage for 2024.

Our View

Our View
Economic Cycle		The economy is in a late cycle. The Fed has hiked aggressively and while the economy has remained resilient to date, the manufacturing industry is showing serious pain, and we anticipate that the lagged effect of monetary policy will start to be felt in other parts of the economy in the coming quarters.
Stock Market		Sentiment around the stock market now appears stretched and valuations are not compelling. To date, market returns have been driven by multiple expansions. EBIT margins climbed to historical highs in the years following COVID lockdowns; elevated input costs and weakening demand and pricing power are posing a risk to the ability of corporations to maintain earnings at their projected level. Returns will be harder to come by and stock selection will be increasingly important.
Bond Market		Interest rates are at a 22-year high, as the economy has remained resilient, and the market is weighing the dynamics of still-elevated core inflation and the potential for interest rates to remain higher for longer. Corporate spreads remain well contained, particularly considering the risks we see to the economy.
Important Issues on the Radar		Inflation: While significantly lower than the 2022-high, factors including a resilient demand environment and wage increases threaten to keep core inflation elevated. Should this be the case, the Fed may remain tighter for longer.
		China’s Economy: China has pivoted on the two key economic issues that acted as severe headwinds to growth over the last two years; however, economic growth appears to be stagnating and it will be critical to monitor the policy response in the coming months./td>

Indicates change Indicates no change

Source: Wall Street Journal. Bloomberg.

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The S&P 500 Index is an unmanaged, capitalization-weighted measure comprised of 500 leading U.S. companies to gauge U.S. large cap equities. The Index returns do not reflect any fees or expenses. Dividends are accounted for on a monthly basis. Index returns provided by Bloomberg.

Index data referenced herein is the property of S&P Dow Jones Indices LLC, a division of S&P Global Inc., its affiliates (“S&P”) and/or its third party suppliers and has been licensed for use by Manning & Napier. S&P and its third party suppliers accept no liability in connection with its use. Data provided is not a representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and none of these parties shall have any liability for any errors, omissions, or interruptions of any index or the data included therein. For additional disclosure information, please see: https://go.manning-napier.com/benchmark-provisions.

The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip U.S. stocks that are generally the leaders in their industry. Dividends are reinvested to reflect the actual performance of the underlying securities. The Index returns do not reflect any fees or expenses. Index returns provided by Bloomberg.

The NASDAQ Composite Index is a broad-based capitalization-weighted index of domestic and international based common type stocks listed in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The NASDAQ Composite includes over 3,000 companies. The Index returns do not reflect any fees or expenses. Index returns provided by Bloomberg.

The Russell 2000® Index is an unmanaged index that consists of 2,000 U.S. small-capitalization stocks. The Index returns are based on a market capitalization-weighted average of relative price changes of the component stocks plus dividends whose reinvestments are compounded daily. The Index returns do not reflect any fees or expenses. Index returns provided by Bloomberg. Index data referenced herein is the property of London Stock Exchange Group plc and its group undertakings (“LSE Group”) and/or its third party suppliers and has been licensed for use by Manning & Napier. LSE Group and its third party suppliers accept no liability in connection with its use. Data provided is not a representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and none of these parties shall have any liability for any errors, omissions, or interruptions of any index or the data included therein. For additional disclosure information, please see: https://go.manning-napier.com/benchmark-provisions.