MARKET RETURNS: Markets staged a dramatic rally into year-end, bringing all major asset classes comfortably into positive territory for 2023. U.S. stocks posted the strongest returns, with the S&P 500 finishing just shy of an all-time high. These gains were largely driven by the “magnificent 7” large technology companies (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla), which benefitted first from management focus on efficiency and then public fascination with artificial intelligence. This led to outperformance for larger companies, growth stocks, and tech and adjacent sectors (communication services and consumer discretionary) in the U.S. Foreign leadership differed, with strong performance for value stocks and cyclical sectors, though technology was the top performer across regions. Bonds finished the year with a total return close to their starting coupon as the 10-year Treasury yield ended up very near where it began despite trading in a wide range throughout the course of the year. Foreign bonds finished slightly ahead of domestic fixed income as the dollar declined in late 2023 after oscillating throughout the year. Cash equivalents generated a mid-single digit return with minimal volatility.
LOOKING FORWARD:
Magnificent Expectations: The year’s most prominent story in equity markets was the dominance of the “magnificent 7”, a group of large U.S. technology-related companies. Beaten down by rising rates and recession fears in 2022, this cohort staged an astounding rebound in 2023. The first phase came early in the year as management teams shifted their focus from growth at all costs towards efficiency. Then enthusiasm around artificial intelligence drove a second wave of price appreciation. These seven companies made up over 25% of the S&P 500 index of large U.S. stocks and over 15% of the MSCI All Country World Index as of year-end and contributed over 58% and 38% of respective 2023 returns according to Morningstar data for ETFs tracking those indexes. Their market capitalization is now roughly equal to that of the stock markets in Japan, the United Kingdom, and Canada combined, as shown in the charts below.
These are great companies, to be sure. Yet great companies do not always make great investments and history suggests their outperformance may be difficult to maintain, as implied by shifting leadership in the chart below. Going forward, the magnificent 7 face challenges of scale and the “big market delusion”. Scale reflects the fact that once a company reaches a certain size, the magnitude of the numbers makes it increasingly difficult to maintain its growth rate. The big market delusion concept acknowledges that when a revolutionary technology comes along, market leaders emphasize that technology’s potential over competitive dynamics. Each company is valued as if it will capture majority market share, which cannot be true in every case. While artificial intelligence is likely to be a dominant force for the next decade or more, its benefits are likely to be more widespread than currently appreciated, similar to the internet in the late 1990s.
Sticking the (Soft) Landing: A key debate among economists and investors throughout 2023 has been whether the Federal Reserve will achieve a soft landing (taming inflation without recession), hard landing (sacrificing economic growth to contain inflation), or no landing (failing to subdue inflation, requiring more drastic measures). The elusive soft landing appears in reach and has only been attained in three hiking cycles since the mid-1950s as shown in the chart below: the mid-1960s, 1980s, and 1990s. The Fed seems to be fulfilling its “dual mandate” of price stability and full employment for now. Inflation as measured by the consumer price index (CPI) has fallen to roughly 3.4% from a peak of roughly 9% in June 2022. Headline unemployment sits at 3.7% as of December, among the lowest readings since the late 1960s.
Yet potential risks exist on either side of the outlook. Geopolitical conflict in commodity-producing regions could lead to a resurgence of inflation and no landing. An escalation in Ukraine or the Middle East may result in supply disruptions and higher agricultural or energy prices, in addition to the humanitarian toll. A hard landing could result from monetary policy impacts that have yet to materialize as effects work through the economy with “long and variable lags”. Areas to watch include the U.S. fiscal situation, consumer finances, commercial real estate, and bank balance sheets.
Conclusion: Last year’s market rebound and economic resilience came as a surprise to most, underscoring the importance of following a strategic plan and seeking to position portfolios to hold up across a range of eventualities rather than a single outcome. Notwithstanding, markets do periodically present opportunities to capitalize on advantageous probabilities. We believe the bond market represents one such opportunity, as attractive yields offer return potential with downside cushion. Japanese stocks may be another example, with shareholder-friendly corporate reform, favorable inflation trends, and a currency tailwind from the yen. And certain alternative investments can enhance portfolios for investors willing to venture beyond traditional stocks and bonds. We’ll continue to survey the investment landscape while hewing closely to our longer- term strategy in the coming year and beyond.
We wish you and your loved ones a happy, healthy, and prosperous 2024!
Index Descriptions:
S&P 500 Index TR is a market capitalization weighted index which represents the broad market for large company U.S. stocks. Returns reflect the reinvestment of dividends.
The MSCI EAFE Index NR USD is a market capitalization weighted index which represents the broad market for large and mid-sized developed market stocks excluding those from the U.S. and Canada. Returns reflect the reinvestment of dividends and foreign withholding taxes and are translated into U.S. Dollars.
The MSCI EM Index NR USD is a market capitalization weighted index which represents the broad market for large and mid-sized developing market stocks. Returns reflect the reinvestment of dividends and foreign withholding taxes and are translated into U.S. Dollars.
The Bloomberg U.S. Agg Bond Index is a market capitalization weighted index which represents the broad market for taxable investment grade U.S. dollar- denominated bonds. Returns reflect the reinvestment of interest.
The US Treasury Bill Auction Avg 1-month is an index comprised of short-term U.S. government-issued investments with yields collected weekly and can be considered a proxy for cash.
Portfolio performance, characteristics, and volatility may differ from the benchmarks shown. Opes portfolios are managed according to their respective strategies which may differ significantly in terms of security holdings, industry weightings, and asset allocation from those of the benchmarks. Benchmarks are unmanaged and provided to represent the investment environment in existence during the time periods shown. An index is not available for direct investment, and does not reflect advisory fees, any of the costs associated with buying and selling individual securities, or any other fees, expenses, or charges. Past performance may not be indicative of future results.
The opinions expressed in this article are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security. All opinions expressed herein constitute the judgment of the author(s) as of the date of the report and are subject to change without notice. The material has been gathered from sources believed to be reliable, however Opes cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. This information may contain certain statements that may be deemed forward looking. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those discussed. Opes does not provide tax or legal advice, and nothing contained in these materials should be taken as such. As always please remember investing involves risk and possible loss of principal capital. Advisory services are only offered to clients or prospective clients where Opes and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Opes unless a client service agreement is in place.
