Investor Optimism Set the Tone for a Strong Finish to 2023

The S&P 500 reversed its 2022 losses, and then some, closing the year near a record high.

A choir of optimistic investor sentiment closed 2023 on a high note, as expectations of “steep cuts to interest rates” may be at odds with the Federal Reserve’s (Fed) actual sheet music. Considering the tumult of the year as sentiment focused on economic and inflation data, this discordance isn’t all that surprising and could signal volatility to come, but in the meantime, the market environment looks a lot brighter at the tail end of 2023 than it did at the close of a dreary 2022.

“December’s rally was fueled by a further deceleration in inflation and the Federal Reserve’s switch at the last FOMC (Federal Open Market Committee) meeting of the year to a more dovish tone and talk of Fed interest rate cuts in 2024,” said Raymond James Chief Investment Officer Larry Adam. “However, it is important to put the positive year of performance into perspective: 2023 was a reset year as the over 25% return for the S&P 500 only recouped all the losses from 2022.”

While the Dow Jones Industrial Average notched seven record highs in 2023, the S&P 500 closed the year less than 1% from all-time highs. Tech-related sectors were the best performers for the year, as the NASDAQ 100 and its leading artificial intelligence stocks saw its best year since the 1999 tech bubble. And small-cap equities, which had been a significant underperformer for the year, showed signs of a resurgence as it was the best performer in the fourth quarter.

Still, it may be too soon to celebrate the Fed engineering a “soft landing” – a return to the target inflation rate without a recession. For one, inflation remains above the 2.0% target. Two, the lagging effects of its rate hike program continue to cool economic activity. And three, the repercussions of higher economic growth or any other geopolitical event with the potential to disrupt food and energy prices could directly influence inflation and shape future Fed policy.