2024 1st quarter investment bulletin
2023: A Powerful Year of Recovery
The stock and bond markets performed exceptionally well during 2023. Despite a pessimistic tone entering the year, stocks and bonds rallied throughout the year. The rally was driven by three primary factors.
A resilient economy avoided recession leading to increasing corporate earnings.
The Federal Reserve raised interest rates seven times in 2022 and four times in 2023 but held rates steady in the 2nd half of 2023. This led to a decline in longer-term interest rates which provided a boost to stock and bond prices.
Lastly, and most importantly, valuations were attractive and very reasonable in 2023, following a down year in 2022.
The Magnificent 7 leads to a Massive Growth Rally
The promise of AI (artificial intelligence) captivated the minds of investors and technology enthusiasts in 2023. The more widespread adoption of artificial intelligence tools such as Chat GPT helped to power growth stocks. The technology heavy Nasdaq 100 increased more than 50%, which was the largest single year gain since 1999.
The meteoric rise of the magnificent seven stocks (Apple, Nvidia, Tesla, Microsoft, Google, Meta and Amazon) helped to power the market higher for much of the first half of 2023. The chart below shows market returns in several indexes for 2023 through July 31st. You can see that the gains early in the year were felt throughout the market, but the extraordinary gains in the magnificient 7 were prominently seen in the technology heavy Nasdaq. While it is enjoyable for the market to move higher, this type of concentration in returns will inevitably pose a challenge. An overreliance on too few stocks to achieve meaningful gains is not a sustainable or healthy market environment. The concentration in returns makes it challenging for diversified investors to stay the course in areas such as value stocks, mid and small-cap stocks, and international stocks.
Late Summer Swoon
The stock market faltered in the late summer. From August through October, stocks declined 12% leading up to the final two months of the year. The table below reveals that as of October 31st:
The Nasdaq was still firmly in positive territory.
The S&P 500, driven by growth stocks, was barely holding on to its double-digit gain.
Other sectors such as small caps, the Dow Jones Industrial Average and the bond market were flat or in negative territory.
Powerful End of Year Rally
Thankfully, the patient investor was rewarded during the stock rally in November and December. The stock and bond market increased significantly to close out 2023. The gains were led by small cap stocks, which increased more than 21% in the final two months. The entire stock market participated, and bonds increased by more than 7% as interest rates began declining to close out the year.
Outlook & Positioning
A year ago, it would be fair to say that overall sentiment was poor around the market following the material losses during 2022. Throughout 2022, we increased allocations to stocks at more favorable prices anticipating the recovery that we had in 2023. As we enter 2024, overall sentiment following the significant gains achieved in 2023 is exceedingly high, but we would argue that the outlook is a bit murkier. When stock prices increase as much as they did last year, the price to earnings ratio increases which is a less favorable position for stock gains. Thankfully, the economy performed well, and corporate earnings increased throughout the year.
In our opinion, the combination of stock gains and earnings growth has resulted in the overall stock market being fairly valued. It does not strike us as materially over or undervalued. However, in some corners of the market (large-cap growth stocks) there is a strong likelihood of significant overvaluation. We will do our best to incrementally sell the portions of the market that are overvalued and position the portfolio in ways that can still achieve growth, but that also have less downside potential.
