2023 Review & 2024 Outlook

Executive Summary

• The Nasdaq-100 had its best annual performance (55.1%) since 1999
• Large-cap Growth outperformed Value by the 2nd widest margin since 1978
• 10yr UST Yield was unchanged YoY following a dramatic decline over the final two months
• S&P 500 corporate earnings expected to grow 2.4% YoY in Q4 and 11.5% in 2024
• The Federal Reserve signaled an end to its 525bps hiking cycle
• Financial conditions have eased dramatically since late October

Last year was a surprisingly strong year for the U.S. stock market despite widespread prognostications for a continuation of the 2022 bear market and a looming recession. The Nasdaq-100 had its best annual performance (55.1%) since 1999, while the broader-based S&P 500 had a more than respectable total return of 26.3%. The blue-chip Dow Jones Industrials underperformed with a relatively modest return of 16.1%; however, both the Dow and Nasdaq 100 were the first of the major equity benchmarks to return to new all-time highs in December. Smaller cap stocks had been the worst performers until the last two months of the year, where over the final nine weeks of 2023, the Russell 2000 and Russell Microcap Indices rebounded with ferocious 24.3% and 28.1% respective returns.

All bull markets have their own wall of worries to overcome, and the current times are no exception. Despite a prolonged and ongoing inversion of the yield curve and now 20 consecutive monthly declines in the Leading Economic Index, a recession never came to fruition, but Q3 real GDP was up 4.9%. 

A bank crisis in March saw the 2nd biggest bank failure in U.S. history, leading to a record three-day decline (-27.1%) for the S&P Regional Banks ETF (KRE). The 30-year fixed mortgage rate rose above 8%, yet homebuilders (ITB ETF +68.9%) were one of the top-performing industries. Meanwhile, the Federal Reserve raised rates four times, culminating in 525 basis points of rate increases since the start of their hiking cycle in March 2022.   

The economy was supported by a range of fiscal and liquidity measures helping to offset the drag from higher rates and the Fed’s ongoing quantitative tightening program. The Inflation Reduction Act (IRA) and CHIPS Act led the fiscal support measures partially offsetting the economic slowdown. 

“As inflation moves down, it’s in a way natural that interest rates should come down somewhat because real interest rates would otherwise increase, which can tend to tighten financial conditions.” - Janet Yellen on CNBC’s “Squawk on the Street,” 11/1/2023

In the first week of November, the Treasury’s Quarterly Refunding Announcement (QRA) revealed noteworthy changes relating to the size and composition of future debt issuance, which contributed to a meaningful reversal in the tightening of financial conditions that had been taking place over the prior three months. A significantly higher composition of Treasury bill issuance versus longer duration bonds is allowing money market funds to absorb a greater percentage of government debt, limiting the tightening impact of higher rates and QT. That same week, a “less hawkish” FOMC combined with a softer monthly employment led to a dramatic reversal in rates. That trend accelerated in mid-November with a softer CPI reading, and in mid-December at the Fed’s FOMC, Chair Powell said policymakers have now turned their attention to rate cuts as inflation continues to decline towards their 2% goal. 

The bond market’s reaction was most profound on the longer end of the rates curve. The 10-year UST Yield went full circle by starting the year at 3.88%, running to a high of 5.02% in October, before declining as much as 115bps in the final two months and finishing at 3.88%. Futures are currently pricing in close to seven 25bp rate cuts by the end of 2024, which is more than double the Federal Reserve’s Summary of Economic Projections (SEP) forecasts for three cuts published at the most recent December FOMC.  

Headline and core inflation are trending lower, leading markets to price in the start of the cutting cycle as early as March. Energy prices are coming off six-month lows, driven more so by the supply side rather than a slowdown in demand. The disinflation trend continued throughout the year, with the core PCE Price Index going from 4.9% in December 2022 to its most recent reading of 3.1% in November 2023. 

Along with the unemployment rate holding near generational lows and consumer spending showing strength, there is increasing confidence the Fed will achieve a soft landing for the economy.  

The sharp reversal in rates over the last two months of 2023 led to a dramatic improvement in breadth and a strong rotation into previously underperforming groups within the equity complex. Since the first week of November, small caps outperformed large, the equal-weight Nasdaq-100 and S&P 500 indices outperformed their cap-weighted brethren, and rate-sensitive REITs and Financials outperformed the high-flying Technology sector.  

Sector Performance

Amongst large caps, Technology (57.8%), Communications (55.8%), and Discretionary (42.3%) outperformed by a wide margin due in large part to the robust gains and strong weighting by the “Magnificent Seven.” Bloomberg’s Magnificent Seven Index returned 107% for 2023. Defensive sectors, including Utilities (-7.1%), Staples (0.5%), and Healthcare (2.1%), underperformed. Along with the Utilities sector, Energy finished down on the year, which is forgivable given the sector gained 47.7% and 59% in 2021 and 2022, respectively.   

Growth vs. Value       

Growth outperformance versus Value returned with a vengeance as the pendulum of relative performance between these two broad categories has swung violently in three of the last four years. Large-cap growth outperformed Value by more than 31 percentage points in 2023, second only to 2020, when it outperformed by more than 35 percentage points. This follows 2022, where Value outperformed growth by more than 21 percentage points, which was its second-best relative performance on record going back to 1978. The ratio of Growth to Value (RLG / RLV) bottomed in the first week of January 2023 and, by mid-November, came within 1% of record highs previously set in August 2020 and December 2021.  

Looking Ahead

The unofficial start to Q4 earnings season kicks off next Friday, Jan. 12, with releases by some of the money center banks. According to FactSet, the estimated Q4 earnings growth rate (YoY) for the S&P 500 is 2.4%, marking the second straight quarter of earnings growth. At the start of Q4, the estimated earnings growth for Q4 was 8.1%. 

Estimated revenue growth for Q4 (YoY) is currently 3.1% versus expectations of 3.9% at the start of Q4. 

The S&P 500’s forward 12-month PE is 19.3 versus the 5-year and 10-year averages of 18.8 and 17.6, respectively.           

The S&P 500 closed out the year with nine weekly gains, marking its longest weekly streak since 1985, also seen in 1989 and 2004. The record of 13 straight weekly gains was set in 1957. Ironically, 2023 was the first year since 2012 that the S&P 500 did not register a new all-time high. The Fed may not deliver on the market’s expectations for six plus rate cuts priced by year-end, yet the hiking cycle is widely seen to be in the rearview mirror. Last year’s outperformers could take a backseat in favor of the recent rotation into small-cap and previously underperforming sectors.  

The rebound over the final two months of 2023 was led by small and microcap benchmarks. In the final two weeks of the year, the Russell 2000 managed to “break out” from an 18-month trading range; however, the final week’s price pattern showed signs of exhaustion along with lower momentum readings (aka bearish divergence), suggesting a period of consolidation could be on hand in the near term. Upside momentum, however, has been broadening with strong participation amongst an increasing percentage of stocks, which should hopefully bode well for 2024.  

^{The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. All information contained herein is obtained by Nasdaq from sources believed by Nasdaq to be accurate and reliable. However, all information is provided “as is” without warranty of any kind. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.}