I think it is fair to say, as we end this interesting and challenging year and head into perhaps the strangest election year ever, that we are faced with a number of confusing issues. Many of the old maps of how things are supposed to work seem to be useless at this point, and it is hard to get our bearings.
Reported unemployment is very low, GDP growth is pretty good, and yet people are pretty unhappy and pessimistic about the economy and the state of our country generally. Inflation was briefly very high, is now lower but still above target, and many basics seem expensive for the average American. Interest rates rose sharply, but then ended the year down a bit, with the market expecting substantial decreases in interest rates next year.
So, the Fed tightening cycle is done and equity markets are soaring, unemployment is low, and we are miserable. How does this work?
Executive Summary – Q4 and YTD Index Returns
First, let’s take a quick look at what happened in Q4 and for the full year. To summarize, equities and bonds rose sharply in Q4, with the S&P 500 not dominating for a change as small and international stocks seemed to respond forcefully to the end of the Fed tightening cycle and the reduction in interest rates.1
The Last Two Years – What a Ride!
As you certainly remember, 2022 was a bad year, not just for equities, but for bonds as well. The story of “transitory inflation” fell apart and the Fed began a rapid tightening, slamming on the brakes and driving financial assets into the proverbial ditch.3
This tightening followed an extended period of the loosest Fed policy in history, with zero short term interest rates and unprecedented “quantitative easing” – i.e., the Fed buying bonds to drive down long-term interest rates and flood the market with cash. And then the party was over.
2022 was a tough year, there was nowhere to hide. The Magnificent Seven stocks really got hammered, falling far more than the broad equity market.
For a while this year was looking reasonably good; then it wasn’t, and then we suddenly (as of November) realized the Fed tightening cycle was over, and the rally began. And now here we are, more or less where we were two years ago. This investing business can make you crazy if you let it.
Play It Again, Sam
Image source: Alamy.
Well, this phrase sums up an important market lesson which was displayed once more these past two years. 2022 began with the S&P 500 index at 4766 (December 31, 2021 close) and ended 2023 at 4770, after a roller coaster ride down as low as 3577 (October 12, 2022)!4
I was reminded of this quote by the two-year experience we just had, really the same old story (a fight for love and glory?). Once more capital markets fell sharply only to rebound, as disciplined investors harvested losses and rebalanced to stay on target and experience the full recovery.
Meanwhile, sadly, and as always, the down market in 2022 led to outflows from equity mutual funds in 2023,5 as undisciplined investors reacted to their short-term losses, sold some of their equities, and missed the recovery. Play it again, Sam.
1. Bowman, Jeremy Bowman and The Motley Fool. “Interest Rates Are Set to Fall in 2024. History Says This Is What Will Happen to the Stock Market.” Yahoo Finance, 3 Jan. 2024, https://finance.yahoo.com/news/interest-rates-set-fall-2024-105600619.html. Accessed 3 Jan. 2024.
2. Source: Morningstar Direct. Data as of 12/31/2023.
3. Adinolfi, Joseph. “2022 Was the ‘biggest Outlier Year’ in Markets History as Stocks and Bonds Both Plunged, Deutsche Bank Says.” MarketWatch, 4 Jan. 2023, www.marketwatch.com/story/2022-was-the-biggest-outlier-year-in-markets-history-as-stocks-and-bonds-both-plunged-deutsche-bank-says-11672859958. Accessed 3 Jan. 2024.
4. S&P 500 daily values, Yahoo Finance. Dat as of 01/03/2024.
5. Morningstar US Fund Flows Chartbook, November 2023.
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The volatilities of any comparative indices included in this presentation may be materially different from the individual performance attained by a specific client in a Team Hewins strategy. In addition, client holdings may differ significantly from the securities that comprise the indices. The indices have not been selected to represent an appropriate benchmark to compare an investor’s performance, but rather are disclosed to allow for comparison to the performances of certain well-known and widely recognized indices. The indices are unmanaged, include reinvestment of dividends, capital gain distributions or other earnings and do not reflect any fees or expenses. Indices cannot be invested in directly. Set forth below are descriptions of the indices included in the presentation.
Past performance is not an indication of future returns. Comments provided herein reflects Team Hewins’ views as of the date of this write up and are provided for informational purposes only. Such views are subject to change at any point without notice. Some of the information was obtained from third party sources believed to be reliable but the information is not guaranteed. Any forward-looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. Due to various risks and uncertainties no reliance should be placed on any such statements or forecasts when making any investment decision. Nothing presented herein is or intended to be investment advice or a recommendation to buy or sell any securities and no investment decision should be made based solely on the information provided. Team Hewins is not responsible for the consequences of any decisions or actions taken as a result of information provided in this writeup and does not warrant or guarantee the accuracy or completeness of the information. There is a risk of loss from an investment in securities, including the risk of loss of principal. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Asset allocation and portfolio diversification cannot assure or guarantee better performance and cannot eliminate the risk of investment losses.
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Index Descriptions
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S&P 500 Index (Large Cap U.S. Stocks): measures the performance of large capitalization U.S. Stocks. It is a market-value-weighted index of 500 stocks that are traded on the NYSE, NYSE MKT, and NASDAQ. The weightings make each company’s influence on the Index performance directly proportional to that company’s market value.
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Russell 2000 Index (Small Cap U.S. Stocks): An unmanaged index that measures the performance of the small-cap segment of the U.S. equity universe. It is a subset of the Russell 3000 Index, representing approximately 10% of the total market capitalization of that index and includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership. Russell Investment Group owns the Russell Index data, including all applicable trademarks and copyrights.
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MSCI EAFE Index (International Developed Stocks): The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization-weighted index that is designed to measure the equity market performance of developed markets, excluding the U.S. & Canada. The MSCI EAFE Index consists of the following 22 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.
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MSCI Emerging Markets Index (Emerging Markets Stocks): is a Morgan Stanley Capital International Index that is designed to measure the performance of equity markets in 25 emerging countries around the world.
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Bloomberg Barclays US Aggregate Bond Index (Investment Grade U.S. Bonds): includes U.S. government, corporate, and mortgage-backed securities with maturities of at least one year.
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Bloomberg Barclays US Municipal Index 1-15 Yr Total Return (Int-Term Municipal Bonds): Index that measures the performance of USD-denominated long-term, tax-exempt bond market with maturities of 1-15 years, including state and local general obligation bonds, revenue bonds, insured bonds, and prerefunded bonds.