January 2024 | The Sun Also Rises
Ernest Hemingway has long been one of my favorite writers, and The Sun Also Rises my favorite of his books. The book focuses on the experience of weary young men returning from World War I, but I’ve always viewed the subtext of the book, and its title, as an allegory for renewal. While the past may be shrouded in darkness, a new dawn brings the potential for light.
Over the last several years the world has faced challenges not seen in generations – war in Europe, surging interest rates, a global pandemic – and markets have reacted as you might expect, with volatility. Just in the last two years we have seen stock markets fall and then rise more than 20% per year, and witnessed the largest Bear Market in long-term bonds since 1980, with the 30-Year Treasury Bond down 29% in 2022 before stabilizing with a 3% gain in 2023.
So what’s next?
While the crystal ball is always a bit hazy, current economic conditions suggest the skies may be clearing and the sun peeking over the horizon. To be sure, war in Ukraine and the conflict in Israel/Gaza are obviously ongoing, and bouts of Covid continue to appear. At the same time, markets seem to have adjusted to the unpredictability these issues often cause, with economically sensitive sectors like oil prices and commodities (the CRB below) returning to their 5-year medians. (1*)
We talked last quarter about the fact that interest rates have returned to pre-Financial Crisis levels. The Federal Reserve is now signaling that they intend to leave rates unchanged in the near-term, with an expectation of easing later in the year. We expect this steady hand will lead to gradual economic expansion in 2024.
One obvious wildcard is that 2024 is an election year. The inevitable political acrimony would seem likely to cloud our impending sunrise. Somewhat surprisingly, history suggests otherwise. The following chart follows the trend in the Dow Jones Industrial Average (Dow) over a four-year presidential cycle going back to 1900. In this graph, the trend is more important than the actual level of the Dow. (2*) The chart shows that there has historically been a significant upward trend in the second half of an election year. (3*)
With equity valuations just slightly elevated and bond yields well-above their 10-year median, we expect stock and bond market returns in 2024 to be near their historical averages.
Our constructive view going into the year should not be confused with Hemingway’s description of the Running of the Bulls at the Festival of San Fermin. Significant progress has been made in weaning the markets from government intervention and we view this as a long-term positive for the economy – fundamentals should drive business decisions, not artificially low interest rates or government programs. But the business cycle has not been repealed and periods of contraction are normal and expected. We will continue to build diversified portfolios with the intention of participating in rising markets while endeavoring to outperform during periods of decline. If successful, this strategy should allow us to build client wealth with reduced volatility. A sunny prospect indeed.
— Brad Dinsmore
1. Chart sourced from Intrinsic.
2. Indices and other financial benchmarks shown are provided for illustrative purposes only. Investors cannot invest directly in an index. Comparisons to indexes have limitations because indexes have volatility and other material characteristics that may differ from a particular hedge fund. For example, a hedge fund may typically hold substantially fewer securities than are contained in an index.
3. Chart sourced from Ned Davis Research, Inc.
