by Brad M. Weafer, CFA | Chief Investment Officer
I have shared many conversations with friends lamenting the newer holiday tradition of the “Elf on the Shelf”. For those unfamiliar, each morning, children wake up to find a “magical” toy elf placed in a different spot in the house. Our kids are led to believe that overnight, the elf returns to the North Pole to report how they are behaving to Santa. The excitement each morning is fun, and the extra threat that Buddy (our elf’s name) is watching can be a useful tool. However, the challenge of finding a new place every evening is a source of stress for many!
Despite the occasional scramble at 6am when you have forgotten to move the elf, my favorite part of the tradition is when my son leaves a handwritten note for the elf asking for very specific wishes for Santa. Though holiday wish lists are often reserved for children, I too have a wish list as we look to the new year. 2023 was an exceptional year for the equity and bond markets broadly, and the BFM strategies experienced strong performance throughout. For this to continue, these are the items I wish for in the new year:
Continued Disinflation
Inflation concerns ruled the market in 2022, leading central bankers to increase policy rates more aggressively than in the past forty years. Since peaking in June 2022, inflation has decelerated sharply (see below), surprising all those forecasters suggesting a replay of the entrenched inflation of the 1970s. This continued disinflation has led policymakers to hold rates steady for the last several months, and even suggest lower rates into the new year, propelling markets higher. Maybe even more important than academic indices, lower real-world prices, including cheaper gasoline, have helped press consumer expectations for future inflation lower (also below). Avoiding the psychological traps of entrenched higher inflation is imperative to consumer behavior and ultimately, economic growth. These survey results are welcome news, and we hope to see this trend continue.
U.S. Inflation (Producer Price Index ex. Food and Energy)
Data Source: Bloomberg
University of Michigan Survey Consumer Inflation Expectations
Data Source: Bloomberg
Record Breaking Unemployment
The resiliency of the U.S. labor market has been a major driver in supporting consumer spending and economic health this year. The unemployment rate was 3.7% as of the last reading in November (see below), marking 22 consecutive months under 4%, a more than 50-year record! This streak went on for 27 months in the late 1960s, and 35 months in the early 1950s. Matching or breaking these streaks would go a long way in supporting stocks in 2024.
U.S. Unemployment and Underemployment
Data Source: Bloomberg
World Peace, No Seriously
Since the end of the Cold War, the global economy has benefited from a sort of “peace dividend”. With fewer resources dedicated to weaponization, investment into more productive areas has been possible globally. Infrastructure investment, social spending, and innovation have all benefited as a result. With a lower probability of major conflict, risk premiums and higher valuations also have supported financial markets and returns. Recent tragic events in the Middle East and Ukraine put a spotlight on a growing risk. “The post-Cold War period is over, and we are moving towards a new global order and a multipolar world,” according to the U.N. Secretary-General António Guterres last summer. Data presented by the Uppsala Conflict Data Program shows a stark increase in deaths from conflict in 2022, and we suspect the 2023 data will show something similar. The U.N. has proposed several reforms aimed at altering this current state, and we hope to see a noticeable change in this alarming trend to the benefit of global citizens, specifically those directly impacted, and to the betterment of the economy and markets.
Deaths in State-Based Conflicts by Region
Data Source: Uppsala Conflict Data Program (2023), Peace Research Institute Oslo (2017). Data includes interstate, intrastate, and extra systemic conflicts that cause at least 25 deaths during a year. Deaths of combatants and civilians due to fighting.
A New Franchise Quarterback
We have been putting an annual BFM holiday wish list together for close to a decade. As a diehard Boston sports fanatic, I like to include one football-related “present” each year. Last year, I neglected this responsibility and may have inadvertently put a jinx on the dynasty. The Patriots organization, under Bill Belichick, has been known for holding to a discipline that hasn’t always matched the commonly accepted principles of the rest of the league. I can’t help but see parallels to building an investment strategy. Occasionally, an approach that works for long periods can look out of step with the rest of the stock market. Managing through adversity is part of building long-term success. This year, it seems obvious that the Patriot’s portfolio is in need of some help to get things on the right track. We hope Santa delivers a franchise quarterback this upcoming draft to get back to the winning Patriot Way.
A Revival for Dividends
Followers of BFM know we have a strong belief in the merits of investing in high-quality companies, as we look for organizations with a demonstrated history of generating strong and durable profitability. A common characteristic of many quality companies is the payment of a quarterly dividend. To pay a steady and growing income to investors requires a company to first generate a healthy and dependable level of cash flow. Despite a long track record of success besting the broader market over time, indices that invest solely in companies with a demonstrated track record of stable dividend growth have trailed the S&P 500 dramatically in 2023 (see below). This underperformance reflects a narrowness in the advancement in the stock market this year, with equity leadership concentrated in just a handful of very large technology-related companies. While the difference has been most noticeable this year, this trend is also evident in the three-, five-, and ten-year history of these indices. A reversal to more traditional long-term outperformance for high-quality, dividend-paying companies is on our wish list for 2024.
S&P 500 vs. U.S. Dividend Focused Indices
Data Source: Bloomberg
Longer Performance Measurement Periods
Everyone is a long-term investor until stocks are falling. One of the many investment lessons of the last few years is that things are never as bad as they seem in the moment when markets are down, and never as good as they feel when they are up. Despite being somewhat arbitrary, the industry fixates on year-to-date and annual figures for investment performance. We have been fortunate with well above average equity returns during 2023 (over 25% for the S&P 500 through December 19th) and equally unfortunate during 2022 with negative returns (-18% for the S&P). Imagine the anxiety that could have been saved by looking at trailing two-year returns of +6% (see below), rather than looking at each year in isolation. With the benefit of hindsight, at the depths of the bear market in 2022, things were not as hopeless as they appeared. You could argue that we should be equally temperate on prospects today. Extending our timeframe for performance review is always more instructive. Extend that timeframe even more to the last five years. That period has had no shortage of drama including political strife and a contested presidential election, a global pandemic that shut down commerce, runaway inflation, and a dramatic change in interest rates. Through all of that, the S&P 500 returned a remarkable 15% per year! The long-run value of equity compounding has been on full display and stands as a helpful reminder for patience with portfolio returns and positioning.
S&P 500 Total Return (12/19/2021-12/19/2023)
Data Source: Bloomberg
Artificial Intelligence Proving More Real Than Hype
New technological innovations are typically met with early and unbridled optimism by equity investors. It is easy to spot exciting new opportunities. Distinguishing the magnitude of the hype versus the timing and level of reality is the challenge. Early predictions for the impact of the internet proved well-founded. This didn’t stop the early excitement from fueling a bubble that eventually disappointed eager investors and took years to generate profits worthy of supporting lofty expectations. The field of artificial intelligence (AI) is fueling a similar debate today. Stocks of companies linked to AI have soared in 2023. Early financial results of several of these companies (Microsoft, for example) have shown reason for optimism that the technology will prove worth the hype. This growth must prove durable to continue to reward investors, and on our wish list is another year proving the returns of 2023 have been justified.
Finding a Few Extra Minutes
The holiday season is largely marked with merriment and joy. It also is a worthy time for some reflection. The holiday season is notable for its sometimes stressful commitments and seems to get busier every year. Between parties, shopping, and remembering to move the elf, it can be easy to miss what is really important. What I want most this holiday season is for all of us to have the chance to carve out an extra few minutes each day for something worthwhile. Spend those few minutes on a date with your spouse, putting down your work to play with your kids, hosting a family party, calling a friend you haven’t seen recently, telling your coworkers you appreciate their efforts, and thanking your clients for their business. I’m reminded this holiday season how short life can be. We should make every effort to make these extra minutes count.
From all of us at BFM, we want to send warm wishes for a very happy holiday and new year!
Market Commentary Disclaimer
This publication is for informational purposes only and should not be considered investment advice or a recommendation of any particular security, strategy or investment product. The information contained herein is the opinion of Boston Financial Management and is subject to change at any time based upon unforeseen events or market conditions.
Professional Designation Minimum Requirements Disclosure
CFA® – Chartered Financial Analyst. Minimum requirements for the CFA® designation include an undergraduate degree and four years of professional experience involving investment decision-making, in addition to successful completion of each of the three CFA level examinations.