Weekly Investment Update (12/22/2023)

Our next Weekly Investment Update will be published on January 5, and our Quarterly Investment Perspective (QIP), which discusses our year-ahead outlook in detail, will be published in early January. We wish you and your loved ones a happy holiday season.

This Week’s Views and Positioning

“Bad news (for the economy) is good news (for financial markets)” has been the trend for the second half of 2023. In recent months, data has indicated a slower growth trajectory for the U.S. economy. For example, the Federal Open Market Committee’s median projection for GDP growth is projected to slow from 2.6% in 2023 to 1.4% in 2024, though growth estimates for this year have been continuously revised upward. Bad news for economic growth helped propel stocks 16% from their October lows, and the Fed’s recent pivot to being open to rate cuts in 2024 underscores the notion that policy may be sufficiently restrictive to return inflation back (or close) to 2%.

With expectations now reset, it is not clear to us that slower growth forecasts for 2024 will need to downshift even further to convince investors that inflation will be less problematic going forward. Although we still believe incoming data needs to indicate progress toward expectations for slowing growth, good news for the economy may not necessarily be bad news for the market going forward as has been the case recently. Housing data received this week (more below) was better than expected, yet the S&P 500 was able to rise 0.59% on the day it was released. Investors may finally believe that the forecasted trajectory of economic growth is consistent with falling inflation and an easing Fed. As such, incremental economic data that meets consensus expectations may once again serve to comfort investors that a soft landing is in the works versus raising concerns that the Fed needs to further tighten policy.

Equity Markets Have Rotated From Mega-Cap Technology Strength to a Broad-Based Rally on the Back of the Fed Pivot

What is happening: This week, the S&P 500 reached a 23-month high as the index rallied to a level within 1% of its all-time peak in January 2022. The S&P 500 has risen 16% in less than two months, the fastest advance since the market was recovering from the initial COVID selloff in March 2020. While equity gains for the beginning of the year were driven largely by a rally in large cap growth stocks with the “Magnificent 7” mega-cap technology stocks propelling the S&P higher, the recent rally has been broad-based, extending to value stocks as well as small capitalization stocks. Month-to-date, the Russell 1000 Value Index is outperforming the Russell 1000 Growth Index, though it continues to lag the growth index on a year-to-date basis with its returns less than half. On the small cap side, the Russell 2000 has rallied 13% month-to-date (vs. 5% for the Russell 1000), exceeding its July peak to reach a high since August 2022; nearly half of the indices’ members made a 63-day high, the fifth highest level ever recorded. Within sectors, financials and industrials have led this month while defensive sectors such as consumer staples and utilities have lagged.

Why it matters: The Fed’s pivot from hiking to guiding toward cutting interest rates has ushered in a broad-based market rally. The past month has been the strongest period of improvement in market breadth this year as the equal weighted S&P 500 outperformed the market capitalization weighted S&P 500 by three percentage points over the last month. As market breadth has historically been a positive sign for equity markets, it is encouraging to see nearly 70% of S&P 500 members mark a new 20-day high as well as the percentage of S&P 500 companies currently above their 200-day moving average reach nearly 80% last week.

An advantage of Bessemer’s diversified equity platform is the ability to participate in investment opportunities across geographies, sectors, and market capitalization. Bessemer portfolios increased exposure at the margins to attractively valued stocks that the investment team believes should benefit from falling rates, such as real estate. At the same time, as we look ahead toward next year, we remain mindful that the Fed has historically cut rates when nominal growth is slowing, a backdrop that can be more challenging for value and small cap stocks, and as a result, investors pay a premium for high-quality companies that can compound growth.

Housing Sector Could See Modest Relief From Fed Pivot Alongside Structural Supports

What is happening: Housing starts unexpectedly increased 15% in November to their highest level since April 2022, driven by single-family activity and unseasonably warm weather in the Northeast. New residential construction, especially single-family permits, has shown remarkable resilience likely because of the structural shortage of housing units compared to demand given a decade of underinvestment in supply since the Great Financial Crisis. Existing home sales increased 0.8% (vs. expectations for a modest decline) to a seasonally adjusted annualized rate of 3.82 million units; however, existing home sales remain severely suppressed at levels currently below the COVID-crisis low, with many current homeowners reluctant to sell their homes as they are locked into low fixed-rate mortgages and would face higher rates with a new home purchase.

Why it matters: While the housing sector continues to face the aftereffects of the Fed’s aggressive interest hiking campaign, the outlook appears to be moving in a positive direction at the margin. Mortgage rates have fallen to 7% from over 8% in October on the back of the Fed’s pivot to guide toward rate cuts in 2024. Historically, a decline in mortgage rates has been positively correlated with existing home sales, signaling that we could see a bounce in sales over the coming months. Still, a reacceleration in existing home sales is likely to be capped unless mortgage rates fall further as many current homeowners are locked into fixed-rate mortgages that are well below market rates. Given this dynamic, we expect an improvement in relative housing activity on the new home side, especially as many homebuilders can offer below market rates given their in-house financing units.

Bessemer portfolio managers have modestly increased exposure to pockets of the building economy that are well positioned over the long term given the structural housing undersupply as well as fiscal stimulus packages and reshoring activity.