Bears Faced An Unexpected Year of Surprises

Estimated reading time: 3 minutes

Defying Expectations

It’s Been a Long Year… for Bears

Bearish sentiment was easy to come by at the beginning of 2023. Not just bearish sentiment on the stock market, but also pessimism over the Fed’s ability to control inflation, the economy’s fortitude to withstand rate hikes, and consumers’ willingness to spend as they embarked on a second year of high and still rising prices.

Despite a moment in March during the regional banking crisis when it felt especially precarious, most things held up well, or at least didn’t blow up into the catastrophe many expected. I was certainly on the cautious side of the fence and did not expect the protracted late-cycle behavior we’ve seen.

Inflation Surprises and Market Dynamics

Inflation came down faster than anticipated, much to the delight of markets as rate-sensitive sectors soared. There were fits and starts throughout the year, but the runaway performance of large-caps versus small-caps was remarkable. Enthusiasm over AI drove a blistering rally in a handful of names, and market bifurcation grew. It is worth pointing out that this type of return pattern, with large-caps outpacing small-caps, is characteristic of markets late in the business cycle. 

A bigger story than stock market performance in 2023 was that of inflation. All four major measures of inflation continued their descent closer to the Fed’s 2% target, but haven’t reached it yet. Nevertheless, markets decided that the Fed is done hiking rates and expect cuts to begin in the first half of 2024. More on that later.

A Defiant Foe Tamed

The celebration over lower inflation is warranted, as it has been public enemy #1 since mid-2021 and the cumulative effects are pinching household finances. The drop in energy prices and goods have led the path downward, but there remains some stickiness in services inflation and shelter that prevented the Fed from signaling the “all clear” even after this much progress.

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