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There were two overriding stories for investors in 2023. One was the continued rise in interest rates. The other was the sudden and dramatic emergence of AI as the new driving force of the technology revolution.

No one predicted the huge impact ChatGPT would have on the markets, and on our daily lives. The S&P 500 ended the year up 24.2 per cent, with those gains concentrated in a handful of tech stocks that became known as the Magnificent Seven. The rest of the index was pretty much flat.

Interest rates were the driving force for the rest of the market. Every time the Federal Reserve Board and the Bank of Canada raised their key rates, the indexes sank a little more. It was only in November that we started hearing dovish noises from Washington that led to a strong Santa Claus rally. The Bank of Canada maintained its Grinch face, but Canadians took their cue from Wall Street and pushed up the TSX Composite by 7.25 per cent in the fourth quarter. Total gain for the year was 8.12 per cent, meaning the TSX went nowhere until the last few months.

In this context, let’s take a quick look back at my predictions for 2023 and see how they fared.

Stocks down early, up late. I said interest-rate increases would continue to depress the markets early in the year. But I didn’t expect inflation would be so high for so long and forecast a pause in rate increases, but no cuts, by the second quarter. I was two quarters off in my timing.

Gains for the TSX and S&P. I predicted a modest gain of 5.8 per cent for the S&P 500. It would have been less than that had it not been for the Magnificent Seven group of tech stocks. For the TSX, my call was 10 per cent to 12 per cent. I was a little too optimistic, expecting more from energy.

Energy stocks would continue to prosper. In fact, they stalled, and the S&P/TSX Capped Energy Index ended the year with a fractional loss of 0.39 per cent.

Rate-sensitive stocks would rebound. This was the hardest-hit sector by far in 2022. I said these securities would not recover overnight but were a good place to start some bargain-basement shopping. For most of the year, that strategy didn’t work out. The good news is we’re finally seeing a turnaround.

Bonds would stabilize. I wrote that the bond market would start 2023 in the same way it ended 2022 – falling. But I suggested that once the central banks eased up on interest-rate hikes, the market would stabilize. It was late in the year when we finally got that signal, but the bond market responded as predicted. The FTSE Canada Universe Bond Index ended the year with a gain of 6.69 per cent, with half of that coming in December.

Over all, I was directionally right on most of my calls. But I didn’t anticipate the surge in the Magnificent Seven. And my timing was off target. So, what now?

The pragmatist in me is whispering to avoid irrational exuberance as we enter 2024. But the outlook for this year is better than at any time since the start of the pandemic.

The Federal Reserve Board has signalled it will start to cut rates this year, probably in the first half. The Bank of Canada will almost certainly follow suit, as getting out of step would risk pushing up the value of the loonie.

Most economists are now tilting toward the soft-landing scenario for the U.S. It’s the holy grail of central bankers, where inflation is defeated without plunging the economy into a recession. Canada may not escape a downturn – in fact, we may be in a technical recession now, depending on how the GDP performed in the fourth quarter (GDP was down 1.1 per cent in the third quarter). But if we do slip underwater, it should be a short and mild recession, as long as the U.S. stays on the plus side.

Inflation seems to be easing. Unemployment is stable. Consumers appear to be moderately optimistic. What could go wrong?

Well, lots of things. Canadians are carrying a huge debt load and even a mild financial crunch could trigger a wave of defaults that would hit the financial sector in particular and the market in general. Or inflation could rebound (the high wage settlements late in 2023 may come back to haunt us). The wars in Ukraine and the Middle East continue to threaten to escalate into something more ominous. Perhaps most disruptive of all, the November election could return Donald Trump to the White House, touching off a crisis that could destabilize U.S. democracy and damage our trade relations with our largest partner.

So we should never take things for granted, however rosy the outlook may appear.

With that in mind, here is my outlook for the year ahead.

The last shall be first. If you want to find this year’s stock winners, the first place to look is last year’s losers. Those were without doubt interest-sensitive equities: utilities, REITs, pipelines, telecoms etc. Virtually all stocks in these sectors were hammered, although most were in rally stage at year-end. I believe that will continue in 2024.

Tech stocks will slow. AI darling Nvidia Corp. (NVDA-Q) saw its shares gain 233 per cent last year. They won’t come anywhere near that in 2024. Microsoft Corp. was up by two-thirds. It’s a great company but I can’t see that happening again. I’m not suggesting tech will fall into a hole, only that stock price gains will be based more on earnings and less on anticipation. Prices are high and last week’s trading, with the Nasdaq down 3.2 per cent, showed the enthusiasm of 2023 may not be repeated this year.

Financials will do well. Last year started badly for the financial industry. The demise of Silicon Valley Bank right out of the gate cast a pall over the whole sector, and the demise of other regional banks soon after raised memories of 2008. Fortunately, there was no Lehman Brothers or Bear Stearns to trigger an international crisis. The Fed acted promptly to make depositors whole and a heart-stopping crisis was averted.

But rising interest rates and the threat of a recession continued to put pressure on share prices. The S&P/TSX Capped Financials Index was in negative territory for most of the year. Only a fourth-quarter rally enabled it to finish 2023 with a gain of just over 9 per cent. I think we’ll see a better performance this year.

Bonds will continue to rally. The bond market rallied at year-end after the signal from the Fed that interest rates are expected to decline in 2024. I believe that rally will continue this year, with prices rising and yields retreating (the two have an inverse relationship). Best bet for capital gains are long-term bonds or the funds that invest in them. They also carry the most risk if inflation rekindles and the central banks are forced to change course.

Cash will lose its attraction. GICs were the darlings of conservative investors in 2023, with even the notoriously stingy major banks offering five-year yields in the 5-per-cent range at one point. But by year-end, the pullback was gaining momentum. Except for special promotions, the major banks were all in the 4-per-cent range for five-year terms. Even the more aggressive smaller institutions, such as EQ Bank, had slipped to 4.25 per cent. Those rates will still appeal to some, but they might be the best we see this year. If you want to lock up your money with a decent return, better act fast.

In sum, securities that thrive in a falling-rate environment should have a good year. As for the rest of the market, be selective and don’t overpay.

Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters.

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