2023 Market in Review: The Great Investment Year No One Saw Coming
The year 2023 was the investment year we had all hoped for, but no one was expecting. Coming off 2022, which saw double digit declines in both equities and fixed income, most Wall Street economists called for a 100% chance of recession in the U.S. economy in 2023. The “Great American Job Market” had other ideas. With inflation coming under control and unemployment rates at historic lows, the American consumer remained strong, corporate balance sheets shrugged off higher interest rates, and the S&P 500 ended the year up an impressive 26.3% total return. Led by the “Magnificent Seven,” the S&P 500 caught fire as artificial Intelligence went from something we watched in futuristic movies to the next catalyst for business productivity across the globe.
The strong return year wasn’t without a touch of pain. Three major financial institutions fell victim to higher interest rates. Silicon Valley Bank, Signature Bank and First Republic saw a run-on deposits as a result of major losses in their bond portfolios and a mis-match on their balance sheets. Fortunately, regulators took swift action to backstop uninsured deposits, and the market pushed forward as positive economic data flowed in throughout the year.
ECONOMY AND THE FED
The last two years have been marked by the Fedal Reserve’s war on inflation, and their aggressive rate hiking cycle. That aggressive behavior came on the heels of non-action in 2021 where the Fed labeled continued price increases as “transitory.” In 2022 the Fed increased the Fed Funds rate by 425 bps points, or 4.25%, and continued that trend by adding another 100 bps of tightening throughout the first half of 2023. It wasn’t until the September FOMC meeting that the Fed signaled a pause in the hiking cycle. Inflation, defined by the Consumer Price Index (CPI), dropped from a high of 9.1% in June of 2022 to 3.4% at the end of December 2023. With the battle against inflation seemingly in the rearview mirror, the Fed again changed its tune in December as Fed Chair Jerome Powell signaled potential rate cuts in 2024. This Fed pivot was one of the markets’ most significant catalysts of the year and sent the equity and fixed income markets soaring into year-end.
Throughout the year, the Fed vowed to remain data dependent, meaning its’ course of action was heavily influenced by the economic numbers produced each month. Popular economic indicators were signaling recession in 2023, but the inverted yield curve and the declining Leading Economic Index failed to correctly predict a recession in 2023. So, what went right?
While we won’t have the final number until the end of January, the U.S. economy, as measured by gross domestic product (GDP), is forecasted to have grown by 2.4% in 2023. This strong economic growth was a result of several factors. The U.S. consumer remained incredibly resilient due to strong household balance sheets and excess pandemic era savings. It also helped that the Americans are working. In 2023 the US economy added 2.7 million jobs, and the unemployment rate sits at 3.7% marking the longest run of unemployment under 4% since the 1960s. 1 Two-thirds of the U.S. economy is driven by the consumer, and a healthy consumer was the biggest catalyst in keeping the economy from recession in 2023.
EQUITIES
Much to the delight of investors, global equity markets rallied in 2023 on the backs of lower inflation, a strong economy, and the emergence of artificial intelligence. The S&P 500 led the way up over 26%, but the index’s return was narrow as the top 10 stocks in the S&P 500 were responsible for 86% of the index return.1 Specifically, the emergence of artificial intelligence sparked a massive rally in several mega cap winners, “The Magnificent Seven”, that pushed the S&P higher while the rest of the large cap market treaded water.
It was a relatively steady year of gains in equity markets. In the first quarter the S&P 500 gained 7.5%, which was the second best start to a calendar year in the last 10 years, but international developed equity markets led the way, increasing 8.5%. The March banking crisis created volatility in the markets due to concerns about cracks in the economy from higher interest rates. However, volatility subsided when the government stepped in to guarantee bank deposits and offer loans to struggling banks. The rally continued into the second quarter adding to the year-to-date gains but slid slightly in Q3 as the “Magnificent Seven” cooled off bringing the rest of the market down with them. The rally picked back up in the fourth quarter with double digit returns across U.S. and developed international equities as the Fed signaled that interest rate increases were effectively done and 2024 could see cuts.
From a sector perspective, technology, communication services, and consumer discretionary were the big winners. What do they have in common? These sectors share the names of the mega cap “Magnificent Seven” stocks that carried the equity markets this year. The sectors that underperformed were energy and utilities. Energy struggled with a 10% decline in oil prices, and utilities were impacted by higher borrowing costs due to elevated interest rates.
Many of the themes we saw in domestic equities held true on the international front. The MSCI EAFE Index increased 18.2% in 2023 with growth stocks leading. Easing inflation and the prospect of a Fed rate cut pushed European markets higher even though Germany, the largest economy in Europe, slipped into recession. Higher interest rates seemed to hit the German economy particularly hard, but the UK was able to withstand the impact of high inflation and borrowing costs. Even with poor economic data from the eurozone and geopolitical conflicts in the Middle East and Ukraine, European equities performed well.
Emerging markets stocks rose close to 10% in 2023 but underperformed the U.S. and European markets primarily due to the sluggish Chinese economy, which struggled since easing Covid restrictions in early 2023. The emerging markets index that excludes investment in China returned over 18.0% this year revealing the lag China had on the broader index.
FIXED INCOME
The 2023 fixed income market saw strong performance from both taxable bonds and tax-exempt municipal bonds. Coming off the worst year in fixed income history, the Barclays U.S. Aggregate Bond Index returned 5.5% and the Barclays Municipal Bond Index returned 5.3%. Volatility was prevalent in the fixed income market as we saw large swings in the US 10-year treasury yield. The Fed started this year with the intention of combating inflation through interest rate increases. Throughout the first half of the year, the Fed raised interest rates 100 basis points leading to continued pressure on the fixed income market. As interest rates rose, so did the volatility in the fixed income market culminating in a 17 year high on the 10-year U.S. treasury peaking at 5.2% in October. Towards the tail end of the year, the Federal Reserve took their foot off the gas and signaled the end of the historic hiking cycle and called for potential rate cuts in 2024. This sent the fixed income market into a rally through year end as the yield on the 10-year treasury dropped to 3.8% from its October high. Due to the inverse relationship between bond prices and yields, this decrease in interest rates led to price appreciation across the bond market. Corporate bonds and credit sensitive bonds performed the best with U.S. corporate bonds returning 8.5% and high yield bonds returning 13.4%.
Municipal Bonds
Tax exempt municipal bonds outperformed credit and treasuries on a tax-adjusted basis in 2023, as this asset class was still in high demand. Yields fell sharply in November and put upward pressure on municipal bonds prices. As a result, the Bloomberg Municipal Bond Index had its highest monthly return since 1986 increasing 6.4% in November.2 The impressive rally continued through year-end as municipal yields fell another 30-40 basis points capping off 2023 with a 5.3% return.
The benefit of higher for longer interest rates is that bond yields are significantly higher than they were for the past decade. This provides higher income for investors looking for wealth preservation in their portfolios to buffer volatility in the equity market. Our 2024 outlook piece will delve into this concept in more detail.
SANDY COVE POSITIONING IN 2023
In 2023, we made several asset allocation changes with the aim of capitalizing on depressed equity and fixed income prices while maintaining our clients’ long-term asset allocation objectives. Our Investment Committee meetings focused on current market conditions and how to position client portfolios for a volatile year in the equity and fixed income markets when the Federal Reserve was still manipulating interest rates. We discussed higher yields in both cash and fixed income as potential areas for investment and agreed on the importance of staying invested and staying focused on long-term financial goals. Out of those discussions came actions which we put into practice in 2023 and communicated to our clients throughout the year.
We made the following asset allocation moves during 2023:
Lower global inflation and peak inflation rates
- Added 5% back to international equity allocation, reducing U.S mid and small cap equities based on more favorable international dynamics.
- Extended duration in fixed income anticipating the end of the interest rate hiking cycle. Adding back some intermediate bonds exposure to begin increasing duration. At year-end, we were still overweight shorter-term bonds versus our normal position and will look to add more intermediate duration to portfolios in 2024.
- Added to U.S. large cap from U.S. small and mid-cap to better align with the total U.S. stock market allocation.
Concerns in the real estate market
- Eliminated our position in REITS due to concerns in the real estate market in the form of stubbornly high interest rates and secular trends. As real estate assets were in largely small and mid-cap sized companies, we added back to those assets classes when we sold the small REIT position in the fall.
The year 2023 serves as a reminder of the importance of staying invested. It’s times like these, when Sandy Cove Advisors can be helpful by keeping clients focused on the big picture in order to achieve their long-term goals. It was a volatile year with a banking crisis at home and war in the Middle East and Ukraine, but markets have a way of surprising us when we least expect it. We’re happy that, with our stewardship, our clients benefited from a great investment year in 2023 that no one saw coming.
Reviewing the events of 2023 provides the backdrop and perspective on our thoughts and outlook for next year. We hope you will enjoy reading our market outlook, which can be accessed here: 2024 Market OutlooK: All Things in Moderation (HYPERLINK THIS)
We wish you all a healthy and prosperous new year. As always, if you have any comments or questions, please feel free to reach out to us.
1 JPM “Guide to the Market” December 31, 2023
2 Baird Advisors: “Municipal Fixed Income Commentary” November 2023