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Fourth Quarter Review: After enduring a three-month, 10% correction into late October, the Standard and Poor’s 500 Stock Index rocketed 16% higher into year end. This move was one of the strongest short-term rallies in 30 years and in the 99th percentile historically. The global bond index concurrently gained 9.5% for the best two-month gain ever. It was an “everything” rally, driven by expectations the Federal Reserve would begin to cut interest rates, with some welcomed broadening of equity market leadership after a year dominated by the ‘Magnificent Seven’. The S&P 500’s fourth quarter gain of 11.7% lagged the 14.0% return for the Russell 2000 Small Cap Index. The MSCI World ex-U.S. Index rose 9.8%, the Bloomberg Aggregate Bond Index jumped 6.8%, while Gold advanced 11.6%.
The Year in Review: At the start of 2023, most economists were calling for an economic recession while a Bloomberg survey of Wall Street strategists overall predicted a decline for the S&P 500 in 2023. A market burdened by Federal Reserve rate hikes and the collapse of Silicon Valley Bank in the first quarter was re- invigorated by the hype surrounding the potential for generative artificial intelligence which immediately boosted tech incumbents such as Microsoft, Google, and Amazon. For the year, the S&P 500 jumped 26.3%, the Russell 2000 Small Cap Index gained 16.8% (virtually all in the fourth quarter), and the MSCI World ex-U.S. Index rose 16.2%. Growth outperformed Value across all market cap categories. In the large cap arena, the iShares Russell 1000 Growth ETF gained 42.6% while the DFA Large Cap value Fund returned 11.5%. The Federal Reserve hiked the overnight rate four times in 2023, stopping in July, and the U.S. Treasury market experienced one of their most volatile years in history. Yet, almost impossibly, the yield of the Ten-Year Treasury Note finished the year at 3.88%, exactly where it started despite getting as low as 3.3% in April and as high as 5.0% in late October. This sharp move down in market interest rates into year-end spurred a rally based on earnings multiple expansion in equities and enabled a 5.5% return for the Bloomberg Aggregate Bond Index. Gold rose 13.1%.
Navigating Around the “Magnificent Seven”: The dominance of a handful of U.S. companies continues to push beyond historic bounds and has created a mockery of benchmark indices. After collectively gaining 75% in 2023, Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla, and Meta comprise 30% of the S&P 500 and dominate returns. They also carry a greater market value than all the stocks in the U.K., China, France, and Japan combined and have helped the U.S. market to reach 63% of world equity market capitalization. While these companies are great, their massive market capitalizations are making them “the stocks that ate the global markets”. While we have gotten the big decision right for many years by dramatically overweighting large cap U.S. versus the rest of the world, it has been virtually impossible for any fiduciary investing for diversification to best the top-heavy S&P 500. The S&P 500 Equal Weight Index, which uses the same 500 firms but gives them, as the name suggests, equal weighting, returned 13.8% in 2023, or just over one-half of the return of its capitalization- weighted brethren.
Looking at 2024: The late year rally reflected increased investor confidence in an economic soft landing, i.e. a goldilocks scenario where inflation continues to moderate while the economy continues to grow. Investors may be getting ahead of themselves as the Fed has projected three reductions in the Fed Funds rate in 2024 while the futures market is pricing in six. The December Core-CPI year-over-year change was 3.9% and the Fed’s long-term target is 2% so there is still work to be done. In the meantime, the market is pricing in both enough economic growth to avoid a recession and support corporate earnings yet declining inflation allowing the Fed to ease aggressively. As 2023 reminded us, events will likely not follow the most widely anticipated path. We certainly cannot predict the future, but we can certainly be prepared by holding a portfolio appropriate for your situation. From a tactical perspective, we believe continued broad equity leadership would be very beneficial to portfolios and we will opportunistically add to the “non-Magnificent 7” and emerging markets. After being buyers of intermediate bond investments in the third and fourth quarters at higher yields, we are less active as we wait to see if investors start to discount less rate cuts.
We thank you for your trust, we welcome the opportunity to discuss your portfolio and our strategy in detail, and we wish you a healthy and fulfilling 2024!