A Reflection On The Year That Was
Friday, January 5, 2024
A new year is always a good time for reflection. I thought this would be a good opportunity to review what happened in the markets in 2023. While the media will tout the returns of the indexes, the reality of returns for most investors will not likely reflect these index-like returns.
Take for instance the S&P 500 index, which had a "headline" return last year, but as said earlier, this headline return is not what many investors saw in their portfolios.
The vast majority of the gain in the S&P this year has come from basically seven stocks, commonly known as "The Magnificent Seven". These stocks are Apple, Alphabet, Microsoft, Amazon, Meta, Tesla and Nvidia. In terms of market capitalization, just these seven stocks have the largest concentration in the index. In other words, the S&P 500 is "top heavy" as these few stocks have a disproportionate effect on the index and accounted for nearly two-thirds of the benchmark's 2023 returns. It could be said that as these seven stocks go, so goes the S&P. They did the heaving lifting for 2023 and the increase in those stocks has skewed the performance of the broader market index. When you pull the curtain back, you see that the performance of the rest of the 493 stocks, or 98% of the stocks that make up the S&P 500, tell a much different story. In fact, according to the Apollo Group, nearly 72% of the S&P 500's stocks underperformed the market in 2023, a record.
2023 was also a year that saw underperformance in the bond market, which had a lagging effect on the 60/40 asset allocations and equal-weighted performance.
In 2023, the Magnificent 7 stocks logged an impressive average return of 111%.
Why is this important for us to review and understand? Because when we look at most portfolio performance across the investor universe, relative to the S&P 500 and NASDAQ indexes, we are likely to be confused and disappointed. So, let's jump right in!
TECH WAS THE WINNER (…and unfortunately, I’m not talking about the Red Raiders!)
It's not surprising given that the "Magnificent 7" stocks make up most of the S&P 500 and Nasdaq 100 index in terms of market capitalization weightings, the Nasdaq index had an amazing year in 2023. The YTD return for the Nasdaq index is more than 54% since the beginning of the year. Impressive.
That up-trend in some of the most shorted and fundamentally weak technology stocks came with the realization that disinflation is becoming a more significant threat than inflation. Too, with the reversal of the Federal Reserve into a more "accommodative" stance on inflation and monetary policy late last year, the sectors that benefit the most from disinflation and lower rates have climbed sharply since the beginning of November, such as the small and mid-cap indexes.
SLIP-N-SLIDE
Another main reason the stock market has rallied since November, along with the about-face by the Federal Reserve, is the dollar's slide. The dollar rallied dramatically during the summer, pushing the stock market lower from August through October. However, at the beginning of November, all that changed as the Federal Reserve pivoted on its policy stance, and stocks bounced higher as a result. Since then, the dollar has fallen much further as stocks have continued to rise. A reversal of weakness in the dollar should be expected, with the dollar being oversold, most likely being a contributor to a much-needed market reset in the first part of 2024.
Successful investing requires... Faith, Patience and Discipline
In addition, the bond rally has also been fueled by the dollar's slide. As with stocks, we should expect a short-term reversal of rates during a dollar rally, which will likely feed fears of inflation in the markets. Given that the market believes the Federal Reserve will soon be in an aggressive rate-cutting mode (a belief I do not share as strongly at this moment), any shorter-term inflationary concerns could push out the odds of a rate cute, adding pressure to stock market performance.
WHO WILL LEAD US NOW?
As we look forward to 2024, the big question is where we go from here? Will the indexes lead the way as they did in 2023, or will we see a new leader emerge? At the beginning of 2023, no one thought the market would end on such a high note. In fact, most of the data at the beginning of the year suggested just the opposite.
The answer to where we go from here in the coming year is that we simply don't know with any certainty. It’s important to remember that this is about probabilities, not certainties. When attempting to determine the market environment, we rely on history, current economic data, and to some degree geopolitics. In 2023, those points of reference were not as predictive as in the past.
While we cannot know for certain, we can make some educated predictions based on the belief that the economy will slow for several reasons: monetary policy (actions to control a nation's overall money supply and achieve economic growth) will become more restrictive along with a continued reversal of monetary liquidity. An economic slow down will contribute to slower growth in inflation, which will result in a lower yields environment. In such an environment of both disinflation and lower yields, earnings growth may become more challenging.
AND THEN THERE'S A PRESIDENTIAL ELECTION THIS YEAR
We are living in crazy town as far as the current political environment goes and it's effect on the economy and capital markets. Need I say more about that? Didn't think so. So... back to our regularly scheduled programming...
REMEMBER OUR MANTRA
The biggest risk to any outlook for 2024 is what happens with Federal Reserve policy, interest rates, inflation, and, importantly, whether a recession can be avoided, and if not, how severe it might be. This is not a question easily answered as many indicators suggest a recession is possible and even likely as we move forward, (but it is important to remember, those indicators suggested the same thing for 2023) while other indicators suggest the opposite. What actually happens is a toss up at best and difficult to predict.
Much like in 2023, in such an uncertain environment in front of us, making a firm commitment is difficult. What we must do however, is stick to our portfolio management discipline and rules of investing. Market environments are seldom if ever predictable.
Remember our mantra: to be a successful investor requires… Faith, Patience, and Discipline. We cannot afford to let short term circumstances change our longer term investment strategies. Let me say that again for emphasis, we cannot afford to let short term circumstances change our longer term investment strategies.
The environment for the last three years, since the pandemic, have been unprecedented in scope and the repercussions are still being felt in many areas of our lives, including the capital markets. Conventional wisdom and market history has been less helpful than in the past, and we are truly still in some uncharted territory.
As 2023 has wrapped up, taking stock (pun intended) of what happened in the markets is essential. As noted above, the performance differential between your portfolio and the markets will likely be substantial for most. Such is particularly the case if you own a well-diversified and balanced portfolio.
But at this point, it is important to refrain from making the most common mistake by investors, and that is comparing our investment plan against Wall Street.
REFUSE THE TEMPTATION TO PLAY WALL STREET'S GAME
Comparison is a root cause of more unhappiness than perhaps anything else. Let me give you an example: Assume that for a Christmas bonus, you received $1000. You would be thrilled until you learned everyone else in the office got $1500. Now, you are unhappy because you received less than everyone else on a "relative" basis. However, are you deprived on an absolute basis of getting an extra $1000?
Unhappiness as a result of comparison is all around us. Instagram, Facebook, Tic Tok (tell me you're not on Tic Tok please), Snap Chat, etc. are all full of pictures of people showing off lavish lifestyles, causing us to compare our own lifestyles to what we see on social media. It's no wonder that so many in our culture are chronically dissatisfied.
Comparison-related unhappiness is for Wall Street's benefit, not ours!
Comparison in financial markets can lead to terrible decision-making. For example, investors have trouble being patient and letting the process and/or plan they have work for them, especially when TV analyst are jumping up and down in total panic or conversely, "band-wagon" exuberance.
For example, you should be pleased if you made 10% on your investments but only needed 5%. However, you feel disappointed when you find out everyone else made 12%. But why? Have you considered that their needs were different? Maybe their risk profile and yours aren't the same. What about their time horizon. Trying to compare portfolios can be akin to comparing apples to oranges unless you understand the context around a portfolio.
The ugly truth is that comparison-induced unhappiness is for Wall Street's benefit, not ours!
Wall Street is built on trying to upset people so that they will move money around in an emotional frenzy. Money in motion creates more fees and more commissions for Wall Street. The result is that investors remain in a constant state of frustration. So here is our lesson: There is a danger in following Wall Street's advice of beating some arbitrary index from one year to the next.
Wall Street wants investors to measure portfolio performance over a twelve-month period. However, that is not a good measure of how you are progressing toward your financial goals. It is simply a single snap-shot in time. It is the same as being on a diet and checking the scales every single day. Wall Street doesn't know your goals; your time-horizon; your circumstances or even the slightest notion of how to help you reach your preferred financial future, because they don't know YOU.
If we knew what the future would be with any certainty, making an investment decision would be easy. However, we don't have that luxury. As investors, we make decisions looking through the windshield, not the rearview mirror. Instead, Wall Street suggests that if your portfolio lags in one year, you should move your money to another strategy. Again, this forces you to chase performance, creating fees and commissions for Wall Street.
In a year like 2023, where primarily seven companies led the S&P 500 index, many individuals, thinking they may have "missed out," will want to change their strategy for next year. As is often the case, such would most likely be a mistake. That's why I frequently remind you that while "fear" is not a good investment strategy, neither is "FOMO", fear of missing out. They are both based on heightened emotion. If at any time you want to review your risk, time horizon or update your goals in-between your yearly reviews, please give us a call as we are available anytime to discuss it with you, and anything else for that matter. We want to be that friend you rely on to help you make sense of the market and it's impact on your future.
WHAT NOW?
Remember, our job as investors is pretty simple – protecting our investment capital from devastating short-term losses so we can still be around to play the long-term investment game. Preservation of capital is almost always a primary objective. If you lose it, you're out.
There is a broad range of potential outcomes in 2024. No one has a crystal ball and therefore one knows with any certainty what this coming year will hold. However, by focusing on managing risk and not allowing our emotions to rule the day, we can safely navigate whatever lies ahead.
2023 was a year that saw over 82% of economists predicting a recession and disruption in the market. You could say that a downturn was not only possible, but probable. It didn’t happen; but all the warning signs were there that it would.
Sometimes... the asteroid misses the earth!
Happy New Year!
(The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.)
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