While it may not feel like it, investors have much to be thankful for this holiday season. Over the past year, investors have navigated both short-term challenges due to interest rate swings, the banking crisis, and political battles in Washington, as well as long-term uncertainty resulting from inflation, the Fed, geopolitical conflicts, and more. And yet, through all of this, major market indices have held onto gains, reversing much of last year's declines. How can investors maintain perspective as they take time to reflect on the past year?

Many major asset classes have made strong gains this year

Financial markets and the economy have defied expectations in 2023. In many ways, the current environment represents the best-case scenario for which investors and economists could have hoped just a year ago. The major indices have been highly volatile this year and are not back to their 2021 peaks, but they are currently set to recoup much of last year’s losses. Interest rates climbed throughout the year but have retreated in recent weeks. The 10-year U.S. Treasury yield, for instance, has declined from just above 5% to just under 4.5%. While a diversified bond portfolio has only returned about 1% this year, this is far better than last year's historic bear market decline.

An important reason for these gains is the health of the economy. One year ago, economists expected a recession by the second half of the year due to Fed rate hikes and early signs of stalling growth. Not only did this not occur, but the job market is still strong, with the national unemployment rate near 3.9%. GDP growth for the third quarter, a 4.9% annualized rate, was quick. The strength of consumer spending, driven in part by excess savings during the pandemic, has helped to drive the demand side of the economy as the supply side recovers. There are signs that this is gradually filtering through to corporate profits, which may have reached an inflection point in the third quarter after three quarters of falling earnings.

Another reason for these trends is the fact that inflation has improved significantly. Major inflation measures, such as the Consumer Price Index (CPI) and the Personal Consumption Expenditures Price Index (PCE), are now in the 3% range on a year-over-year basis, down from highs of 9.1% and 7.1%, respectively. On a month-over-month basis, inflation improvements are even more striking with the CPI index flat from September to October. Other measures, such as the Producer Price Index (PPI) which measures inflation for businesses, have improved even more.

Inflation has improved

Unfortunately, slowing inflation rates do not mean that prices will decline—only that they will rise at a slower pace. While this provides some relief, many households, especially those in or near retirement, may continue to find higher prices challenging. From an investment standpoint, however, both stocks and bonds have already benefited from greater price stability. The fact that the Fed may be near the end of its rate hike cycle is welcome news.

For example, technology-related stocks have been particularly sensitive to inflation and interest rates due to the forward-looking nature of their products and businesses. While they have performed well over the past decade, they also led declines in 2022 when rates rose suddenly. Decelerating inflation and stable interest rates have helped this group drive markets higher this year. Sectors such as Information Technology, Communication Services, and Consumer Discretionary have led major indices. As inflation continues to improve, the hope among many investors is that other sectors will begin to benefit as well.

The bottom line? Investors do have much to be thankful for this year. This can be difficult to recognize since it often feels as if markets move from one crisis to another. With the benefit of perspective, it's easy to see that the economy and financial markets have come a long way this year, potentially setting a more positive stage for investors in the year ahead.

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