Insights

Fourth Quarter, 2023 Market Review

January 23, 2024

Dear Clients,

Reflecting on the events of 2023, Jeremy Grantham’s words from our year-end letter in 2022 resonate profoundly: “Be aware that the market does not turn when it sees light at the end of the tunnel. It turns when all looks black, but just a subtle shade less black than the day before.” Little did we foresee how fittingly this quote would encapsulate the unfolding year.

Self-proclaimed industry experts predicted an impending recession since the start of the year; yet contrary to their forecasts, 2023 emerged as an opportune period for long-term focused, disciplined investors. The U.S. stock market, recovering from its most challenging year in more than a decade, concluded 2023 with an impressive 26.3% gain. Developed markets outside the US also experienced robust growth, boasting an 18.9% return, while emerging market equities secured a 10.5% increase. Wall Street analysts failed to anticipate such sizeable returns for the year, which underscores the futility of guessing where markets may be headed; it is simply not a reliable way to invest.

Successful navigation of the financial landscape demands a commitment to time in the market. Consider the last nine weeks of 2023 when global stocks surged 16%. Investors sitting on the sidelines during this period would have earned a paltry 4.5% annual return in contrast to the noteworthy 21.5% through year-end.

Inflation and interest rates once again played a crucial role in 2023 as they did in 2022. To tackle inflation, the Federal Reserve raised rates four more times during the year, bringing us to our current rate of 5.5%. The Consumer Price Index (CPI), which reached its peak of 9.1% in June 2022, decreased to 6.4% by January 2023 and to 3.1% by November 2023. Although inflation was still above its 2% target, the Fed paused its actions starting with their July meeting.

Consequently, bond markets experienced heightened volatility throughout the year. The 10-year US Treasury yields commenced and concluded the year at approximately 3.8%. However, during this period, they surged to a peak of nearly 5%, marking the highest point in 17 years. The announcement by the Federal Reserve about its potential interest rate cuts in 2024 served as a catalyst for a substantial bond rally in the fourth quarter. Notably, the Bloomberg U.S. Aggregate Bond Index concluded the year with an impressive 5.3% return.

Widening Dispersion In Equity Market Cap and Style

In reversal from the substantial sell-off in 2022, large-cap growth stocks emerged as the primary driver of U.S. stock market returns in 2023.

In particular, U.S. Small Value stocks lagged during the first three quarters. However, a remarkable turnaround occurred in the final two months, with these stocks posting substantial gains of 19.2%. This resurgence played a key role in narrowing the performance gap as the year concluded. Outside the U.S., small-cap value stocks performed notably well in both international and emerging markets. This underscores the significance of global diversification. Diversifying investments across different regions allows investors to tap into potential gains from various parts of the world, which are not consistently accessible by focusing solely on the domestic market.

The Media’s “Magnificent Seven” Dominate

Another major storyline has been the continued concentration of the U.S. equity market with Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVIDIA, and Tesla—driving nearly half of the U.S. stock market’s overall gain.

These seven giants now represent almost 28% of the entire S&P 500. It’s worth noting that the combined market value of these companies reached a staggering $11.7 trillion by the end of 2023. To put it in perspective, this is equivalent to the combined stock markets of the UK, Canada, and Japan.

Taking Lessons From History

As companies ascend to domination of the US market, their returns can be impressive. However, a closer look at historical data reveals a consistent pattern: shortly after entering the top 10 by market cap, these stocks, on average, have fallen behind the overall market. It’s a cautionary tale for investors expecting sustained outperformance from what the media commonly refers to as the Magnificent 7.

This historical insight should encourage investors to diversify their investment portfolio. Instead of solely pursuing exposure to mega-cap stocks, diversifying portfolios becomes a prudent approach to capture long-term market growth. By doing so, investors position themselves not only to reap the benefits of the existing giants but also to seize returns from companies that may ascend to the top in the future. It’s about balancing the allure of established giants with the potential opportunities offered by emerging stars in the market landscape.

When navigating the realm of value investing, it’s easy to overlook the fact that the risk-reward equation is played out over the long haul. Financial history reveals a noteworthy trend: the frequency of a positive value premium consistently climbs over extended time horizons. As we stretch the measured time, the likelihood of a positive value premium tends to rise.

Still, even with impressive long-term outcomes, don’t be surprised if there are moments of extended underperformance. We’re right in the thick of it now, navigating through a plot twist or two. In essence, value investing demands a patient understanding of its cyclicality, acknowledging that despite the overarching positive trajectory, temporary setbacks are an inherent part of the journey.

Lastly, it would not be a proper year-end review if we did not poke some good-natured fun at the failed 2023 predictions of Wall Street “experts.”

Thank you for your continued trust and partnership.

THE LOURDMURRAY TEAM

Download and print a copy of this publication.

⁶ Source: Goldman Sachs, US Stocks are Forecast to Have Less Pain but No Gain in 2023, November 23, 2022
⁷ Source: CBS News, Stocks close out 2023 with a 24% gain, buoyed by a resilient economy, December 23, 2023
⁸ Source: Wells Fargo, Wells Fargo Investment Institute 2023 Outlook: A Year of Recession, Recovery, and Rebound, December 9, 2022
⁹ Source: Federal Reserve Bank of New York, Effective Federal Funds Rate
¹⁰ Source: Bloomberg, Outlook 2023
¹¹ Source: IMF.
¹² Source: Morgan Stanley, Stock Market 2023: Reasons for Optimism, February 2, 2023
¹³ Source: CNBC, Asia markets wrap up last trading day of 2023 with small declines; China stocks inch higher as tech firms continue to rise, December 29, 2023
¹⁴ Source: The Wall Street Journal, How Is China’s Economy Doing? Not Nearly as Well as China Says It Is, December 6, 2023