January 11, 2024

December closed the book on a tumultuous year in financial markets.

2023 will be remembered as a year in which we saw no shortage of challenges both global and domestic. These included, but were not limited to,  a regional banking crisis, a debt ceiling standoff in Congress, unprecedented rate hikes from the Federal Reserve, an ongoing war in Russia/Ukraine, signs of another international conflict rising in Gaza, etc. However,  2023 should also be viewed as a superb example of the beauty of financial markets and the importance of staying the course as a long-term investor.

Despite all the anxiety inducing headlines, the worrisome reports of international conflict abroad, and calls for a 2023 recession among talking heads, investors who kept their cool and invested for the long term were rewarded with strong returns from major financial markets. According to data from JP Morgan, after posting the worst returns since the Global Financial Crisis in 2022, a generic 60/40 portfolio (60% S&P 500 / 40% Bloomberg U.S. Aggregate Bond Index) bounced back in 2023 to deliver an 18% return for the year. It would have been easy at the beginning of the year for investors to seek safety in cash and wait for a “better” time to invest.

Maybe wait it out until a time when inflation had returned to normal, or we weren’t staring down the barrel of several more rate hikes, or a recession looked less likely. As informed investors who have studied markets already know, timing these events is difficult and often quite dilutive for long-term returns.  When investors had every reason to be wary, it was those that kept a long-term perspective that were rewarded.

Domestic equity markets closed out a strong fourth quarter with a continued upswing in December capping off impressive returns for the full year 2023. Resilient consumer spending, slowing inflation and wage growth readings, as well as low unemployment numbers provided a broadly positive macroeconomic backdrop for equities throughout the year. Large stocks lead the way in 2023 with the S&P 500 and NASDAQ returning 4.5% and 5.6% for December, bringing their full year returns to 26.3% and 55.1% respectively. In a throwback to years past mega-cap tech companies such as Microsoft, Apple, Nvidia, Meta (formerly Facebook), and Amazon carried both indexes to their performance results. Not to be out done, December saw small-caps post their largest single month return in the last three years with the Russell 2000 Index surging 12.2% to pull their 2023 total return to 16.9%.

Small-caps were likewise lead by tech, but also saw strong contributions from industrials, consumer staples, and the consumer discretionary sectors. The open question of the fabled “soft landing” for the U.S. economy and markets still looms as we look ahead to 2024. Short term interest rate futures still predict several rate cuts from the Fed over the course of the year and it remains to be seen if the U.S. consumer can remain as resilient in the year ahead. Investors can take some comfort in knowing that we enter 2024 with the U.S. markets and economy in as good or better shape as we entered 2023.

International equity markets also saw a rebound in 2023 with notable performance in December as well. Developed markets as represented by the MSCI EAFE Index returned 5.3% for December and 18.2% for 2023. Major markets like the Eurozone (particularly France & the U.K.) and Asia Pacific were the biggest contributors to positive performance as inflation and forward interest rate expectation began to broadly moderate throughout the year. Looking forward to 2024, we believe equity valuations abroad look relatively attractive when compared to U.S. equities and most markets have seen some late year strengthening of their currencies against the U.S. dollar.

Elsewhere, Emerging markets - as represented by the MSCI EM Index - delivered modest returns posting 3.9% in December and 9.8% for the full year 2023. China, the largest individual country in market-cap weighted EM indices, continues to weigh on emerging market returns as it delivered its third consecutive year of negative performance. A slow approach to “re-opening” following COVID as well as mounting issues in its real estate sector have pushed the Chinese economy and financial markets into turmoil that may not be quickly remedied. However, despite the deadweight from China the remaining constituent EM countries were broadly positive on the year with noteworthy contributions from Taiwan, India, South Korea, and Brazil.

U.S. fixed income markets weathered their own share of volatility through December and the whole of 2023. A casual observer comparing the year-end 2022 yield curve to the December 2023 curve would find relatively little change in rates outside of the one-year note, but this would belie the turbulent path interest rates travelled over the course of the year. After reaching its low of 3.25% in April and eventually flirting with 5% yields as recently as mid-October, the10-year Treasury fell dramatically through the remainder of the fourth quarter to close the year at 3.9%. At a total return of 6.8% for the fourth quarter, the Bloomberg U.S. Aggregate Bond Index delivered the highest single quarter of returns since 1989. The Bloomberg U.S. Aggregate Bond Index posted a robust 3.8% return in December alone, bringing the full year returns to 5.5%.

Most fixed income sectors benefited from the easing of rates, but corporates and high yield issuances also saw particularly strong performance as a result of late year credit spread contractions. Despite an erratic rate environment over the last two years, we enter 2024 with attractive absolute yields at levels higher than we have seen over much of the preceding decade. Diversified investors with a long-term perspective can now look forward to the opportunity for meaningful forward returns from the fixed income portion of the portfolio.

After several volatile years post-COVID, commodities saw a somewhat subdued 2023 with the S&P GSCI Commodity Index closing down 4.3% for the full year on the heels of a particularly weak fourth quarter. The energy sector posted its first down year since COVID with crude oil closing the year at $71/barrel from highs of $122/barrel in mid-2022. The remaining components of the GSCI, including livestock, agricultural products, and industrial metals, were flat to down mid-single digits with the lone bright spot being precious metals which were buoyed by strong performance from gold. Weaking trends in energy and food prices have contributed to moderating inflation as we enter 2024 seeking more normalized inflation levels.

As we reflect on the year that was, 2023 was certainly not without its own trials and tribulations but investors should take solace in the fact that despite every headwind we faced it was a particularly bright year for long-term oriented portfolios. Much of the ability for informed investors to endure challenging years like 2023 stems from having a financial plan and sticking to it – through thick and thin. 2024 will undoubtedly bring its own unique series of challenges but keeping a cool head and an appropriate perspective on broader financial goals beyond a single calendar year is paramount to withstanding the day-to-day uncertainties of investing.

Hunter Brooks
Portfolio Manager