Q4 2023 Insights
Global equity markets posted strong gains for the fourth quarter, as declining long-term interest rates and easing inflationary pressures lifted prices of both stocks and bonds. The solid quarterly returns capped off a positive year characterized by enthusiasm for artificial intelligence, equity market concentration at the top-end, and the general resilience of the U.S. equity market (and economy) over its peers, even in the face of a mini-banking crisis, heightened geopolitical tensions, and high interest rates.
As we turn the page into a new year, valuations are elevated but optimism abounds for a continuation of last year’s advances. However, several risks could challenge that enthusiasm. There are high-profile elections this year, both in major developed and emerging markets; wars rage on several continents and are contributing to new global supply chain bottlenecks; and the outlook for future corporate earnings is foggy. How should investors approach such a market environment?
First, while U.S. elections typically add to short-term market volatility, the victory of one political party over the other has not had a meaningful impact on long-term market returns. In fact, since 1974 the best-performing periods for U.S. equities have come during divided government,¹ which as of today remains a probable outcome of the 2024 election. Furthermore, geopolitics has never been a reliable predictor of financial market returns, and the U.S. market is relatively insulated from the current flash points (particularly with regards to shipping disruptions). Finally on earnings, last year the top 10 stocks in the S&P 500 Index generated 30% earnings growth while the remainder saw their earnings contract by -8%.² That sets a very high bar for those top 10 firms to meet in 2024, but it offers more upside potential for the other 490 constituents of the index.
We do not know if markets will offer up a repeat of last year, or if the best performers in 2023 will be the worst performers in 2024. What history has taught us is that the left-tail events that may trigger a sell-off, or the right-tail advancements that may unleash animal spirits, most likely are not on investors’ radars at the moment. We lean into that uncertainty by choosing asset allocations with the appropriate risk/return profile, as well as remaining broadly diversified and not over-exposed to any one company, industry, sector, or country.
Q4 Financial Markets Performance
Equities
U.S. stocks advanced most during the final two months of the year, as expectations grew that interest rate cuts were nearing (see Exhibit 1). Declining inflation and slightly softer economic growth will likely allow the Federal Reserve to begin cutting rates sometime in 2024. Top-performing sectors were those most sensitive to interest rates, including information technology, real estate, and financials. Falling oil prices put downward pressure on energy stocks. Small- and mid-cap stocks outpaced large caps for the quarter, but still finished the year behind. Growth generally outpaced value, except in small caps, where interest rate sensitive companies in the financial services and real estate sectors make up a significant part of the index.
Non-U.S. developed market stocks moved higher as well, benefiting from softer inflation figures and expectations that the rate cycle had reached a top. In the Eurozone, rate-sensitive sectors (i.e., technology and real estate) advanced strongly. U.K. stocks also performed well, but a strengthening of the pound vs. the U.S. dollar held back larger companies. Meanwhile in Japan, a relative strengthening in the yen was a headwind for local exporters, but stocks still advanced.
Quarterly performance of emerging market stocks was positive despite weakness in its largest constituent, China. Declining inflationary pressures in Brazil and India, as well as robust tech-related exports in Taiwan and South Korea were major performance drivers. Poland and Mexico also performed well, as political risk eased in the former, while the latter continued to benefit from supply chain near-shoring. Meanwhile, China’s ongoing real estate crisis and uncertainty over its regulatory regime continued to worry investors in local equities.
