Between continued volatility in equity markets, an impending election, and ongoing concerns around interest rates, today’s financial world is more uncertain than ever. 2022 was a rough year and led to predictions that 2023 would end in the red. However, 2023 defied expectations. So, let’s dive into what that could mean for investors in 2024.
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U.S. Equities — How Did We Get Here & Where Are We Headed?
In the last two months of 2023, the S&P 500 had some of the best results we’ve seen in decades. In 2023, the S&P 500 ran 26% despite analyst projections, following an 18% fall in 2022. Over the last 10 years, the S&P 500 has annualized returns of approximately 12.1%, so despite volatility year to year, we’re optimistic about the market’s outlook going forward.
Many clients ask us, “What’s been working, and where should I invest?” Last year, we saw growth stocks significantly outperform their counterparts. Large-cap growth stocks led the way ending with 30% returns, largely in part due to a group of stocks called “The Magnificent Seven.” While this aligns with what we’ve seen in 10-year annualized returns, over the last decade, we’ve also seen strong performance from small-cap and REIT stocks as well, so it’s important to remain diversified across the various asset classes.
Source: Compustat, FactSet, Federal Reserve, Refinitiv Datastream, Standard & Poor’s, J.P. Morgan Asset Management.
Dividend yield is calculated as consensus estimates of dividends for the next 12 months, divided by most recent price, as provided by Compustat. Forward price-to-earnings ratio is a bottom-up calculation based on IBES estimates and FactSet estimates since January 2022. Returns are cumulative and based on S&P 500 Index price movement only, and do not include the reinvestment of dividends. Past performance is not indicative of future returns. Guide to the Markets - U.S. Data are as of January 31, 2024.
Performance Across Equity Classes
Let’s face it: few investors and analysts had high hopes for 2023’s market performance. The year started off strong, but we faced pullbacks and volatility starting in July that seemed to solidify the beliefs that 2023 would have mediocre returns. From July 1st to September 30th, 2023, the S&P500 (a large-cap blend of stocks) fell 6.31%. Internationals fell almost 20% to .48%, and bonds were down 2.5%. But then, the tides shifted.
From October 1st through the end of the year, we had one of the best two-month runs we’ve seen in the market. We saw bonds run up almost 6%. Internationals rebounded and ended the year up almost 16%. The S&P 500 took off and ended the year at over 26% returns.
The Magnificent Seven
2023 was an interesting year for investing, in part due to the performance of the top seven big tech companies (dubbed the “Magnificent Seven”) in the S&P 500. The S&P 500 had a total return of 26% in 2023. But the so-called Magnificent Seven—Amazon, Apple, Google (Alphabet), Meta, Microsoft, Nvidia, and Tesla—grew a staggering 107.3% in 2023. If we look at the equal-weight total return of the S&P 500, it has only gone up 14%. These seven companies are what held up the US stock market last year.
By year-end, the top 10 stocks made up 32.1% of the S&P 500, but those same 10 stocks only account for 23.2% of the earnings over the last 12 months. The low earnings and high prices mean the market is expecting a high rate of earnings growth for these companies in the coming months. If their earnings do not grow in line with lofty market expectations, we could see downward pressure on these names.
Over the long term, we've seen large-cap growth and blend stocks outperform with 10-year annualized returns of 14.9% and 12.1% respectively. Historically over the last 60-80 years, small and mid-cap stocks have provided excess returns over large caps. However, in the last 10 years, large-cap stocks have outperformed with the rising success of technology companies. While past performance isn't indicative of future results, these historical results can provide an interesting lens for considering various investment strategies.
Are We Headed Toward Recession?
Following the impacts of COVID-19 in 2020, economists and strategists have predicted a recession since late 2021. However, two years later, there’s still no recession in sight as we kick off 2024. The New York Fed recession probability indicates a 62% chance of recession in the next 12 months; however, we believe if we do see a recession, it won’t be anything like 2008 or the COVID recession.
Despite ongoing inflation and interest rate hikes, consumers have remained resilient, and their spending has bolstered company earnings growth. Among the six indicators provided by NBER for recession probability, we see the trends heading in a direction that doesn’t imply that we’re going to see a recession right away. However, only time will tell where the market will go and if economic conditions will shift to keep us from a recession in the next 12 months.
How Should My Investments Shift for the Upcoming Presidential Election?
During election years, we often have clients asking if it’s time to get out of the market or change investments based on who’s in office. However, we’ve had good and bad markets under Republican and Democrat presidents, and we’ve had volatility during election years and the years that followed. S&P Global ran a study that looked at the S&P 500 from 1928-2021 and found that the average return during US election years was 11.57% and for the years after elections was 10.67%. What does this tell us? We shouldn’t be changing our investment strategy or pulling out of the market because of an election. It’s important to keep to our long-term strategy instead of making shortsighted choices in the face of uncertainty.
Are U.S. Equities Overpriced?
Many investors express concerns that valuations are expensive, but the valuations for U.S. equities dropped dramatically throughout 2022 and slowly crept back up in 2023. By year-end, the S&P 500 had a forward price-to-earnings ratio of 19.51x. Something we’re watching closely is the quarterly earnings growth to see if we’ll have multiple expansions or an overstretched market. Going forward, we hope to see earnings growth on the S&P 500 that justifies the high multiples. If we don’t see that growth, we’ll start being concerned. However, today while the S&P 500 is above the 30-year average of 16.59x, we consider valuations slightly above fair value; not expensive, and not cheap. 
Source: FactSet, FRB, Refinitiv Datastream, Robert Shiller, Standard and Poor’s, Thomson Reuters, J.P. Morgan Asset Management.
Price-to-earnings is price divided by consensus analyst estimates of earnings per share for the next 12 months as provided by IBES since January 1999 and by FactSet since January 2022. Current next 12-months consensus earnings estimates are $245. Average P/E and standard deviations are calculated using 30 years of history. Shiller’s P/E uses trailing 10-years of inflation-adjusted earnings as reported by companies. Dividend yield is calculated as the next 12-months consensus dividend divided by most recent price. Price-to-book ratio is the price divided by book value per share. Price-to-cash flow is price divided by NTM cash flow. EY minus Baa yield is the forward earnings yield (consensus analyst estimates of EPS over the next 12 months divided by price) minus the Moody’s Baa seasoned corporate bond yield. Std. dev. over-/under-valued is calculated using the average and standard deviation over 30 years for each measure. *Averages and standard deviations for dividend yield and P/CF are since November 1995 due to data availability. Guide to the Markets – U.S. Data are as of January 31, 2024.
Asset Classes & International Markets
In the volatile market of 2022, Commodities led the way, closing out the year with 16.1% returns. However, in 2023 they were the worst performer with –7.9% returns. The leaders for 2023 were Large-cap stocks with 26.3% returns for the year, followed closely by Developed Market equities (18.9% returns) and small-cap stocks (16.9% returns). The lagging asset classes besides commodities still yielded positive returns for the year with cash seeing 5.1% returns and fixed income at 5.5% returns.
While it's important to avoid chasing what's run recently, it's also essential to understand what causes shifts among the various market sectors and asset classes.
Early in 2022, we believed international equities would be among the highest-performing asset classes. However, volatility in Russia, China, and Ukraine last year caused an almost 20% drop in Emerging Market Equities. Despite ongoing volatility in Russia and China and the outbreak of war in Gaza, Emerging Market Equities rebounded to a 10.3% return for 2023.
Source: Bloomberg, FactSet, MSCI, NAREIT, Russell, Standard & Poor’s, J.P. Morgan Asset Management.
Large cap: S&P 500, Small cap: Russell 2000, EM Equity: MSCI EME, DM Equity: MSCI EAFE, Comdty: Bloomberg Commodity Index, High Yield: Bloomberg Global HY Index, Fixed Income: Bloomberg US Aggregate, REITs: NAREIT Equity REIT Index, Cash: Bloomberg 1-3m Treasury. The “Asset Allocation” portfolio assumes the following weights: 25% in the S&P 500, 10% in the Russell 2000, 15% in the MSCI EAFE, 5% in the MSCI EME, 25% in the Bloomberg US Aggregate, 5% in the Bloomberg 1-3m Treasury, 5% in the Bloomberg Global High Yield Index, 5% in the Bloomberg Commodity Index and 5% in the NAREIT Equity REIT Index. Balanced portfolio assumes annual rebalancing. Annualized (Ann.) return and volatility (Vol.) represents period from 12/31/2009 to 12/31/2023. Please see disclosure page at end for index definitions. All data represents total return for stated period. The “Asset Allocation” portfolio is for illustrative purposes only. Past performance is not indicative of future returns. Guide to the Markets – U.S. Data are as of January 31, 2024.
From a valuation perspective, as of December 31st, 2023, international equities' price-to-earnings ratio was around 12.9x while the U.S. remains closer to 19.5x – international equities are discounted by 66% comparatively! We hear that many people believe that international stocks consistently underperform compared to domestic equities; however, there are periods when U.S. equities underperform for years compared to international equities and vice versa. Take for example the period from 2003-2008: the S&P 500’s total return was about 49%, but the total return for the MSCI ACWI index for internationals was over 92%! What's essential to keep in mind is that what's worked recently may not work in the future.
Source: FactSet, MSCI, Standard & Poor’s, J.P. Morgan Asset Management.
Guide to the Markets – U.S. Data are as of January 31, 2024.
Inflation Concerns and What it Means for Investors
Inflation in the U.S.
In June 2022, we reached 9% for headline CPI (levels we haven’t seen since the 1980s), before slowly declining in later months of the year and into 2023. As of December 2023, headline CPI dipped to 3.4%. However, ongoing high shelter and transportation costs are keeping core CPI higher than the Fed’s expectations as food and core goods’ prices have declined in recent months. With the Fed’s hawkish stance on interest rates, this is an area we’re keeping close watch over.
Interest Rates Amidst Rising Inflation
Following the near-zero interest rates in 2020, the Fed completed its first federal fund rate increase in early 2022. Since then, we’ve seen the federal fund rate spike from 0%-0.25% in March 2020 to over 5% as of May 2023. This is the fastest-ever spike in the federal funds rates! The goal of these rate hikes is to fight persistently high inflation, but these rates impact everything from mortgage costs to savings accounts.
A question we’ve gotten from many of our clients lately is, “The Fed hasn’t raised rates since July and inflation is down from last year, so shouldn’t rates come down soon?”
We don’t foresee rates coming down anytime soon, however, the market projects a 63% chance of a rate cut by March. Market expectations also believe the Federal Funds Rate will drop from 5.25-5.5% to about 3% by the end of 2025. Upon the Fed’s decision to stop raising rates, whenever it may be, we’re optimistic that we’ll see the economy and stock market take off as we shift away from a “tightening” market.
Source: Bloomberg, FactSet, Federal Reserve, J.P. Morgan Asset Management.
Market expectations are based off of USD Overnight Index Swaps. *Long-run projections are the rates of growth, unemployment and inflation to which a policymaker expects the economy to converge over the next five to six years in absence of further shocks and under appropriate monetary policy. Forecasts are not a reliable indicator of future performance. Forecasts, projections and other forward-looking statements are based upon current beliefs and expectations. They are for illustrative purposes only and serve as an indication of what may occur. Given the inherent uncertainties and risks associated with forecasts, projections or other forward-looking statements, actual events, results or performance may differ materially from those reflected or contemplated. Guide to the Markets – U.S. Data are as of January 31, 2024.
What's in Store from The Fed: Interest Rates & Fixed Income
Fixed Income
2022 was the worst year on record for bond performance with a negative return of 17.8%. But, much like with equities, we saw volatility and a year-end run-up in the bonds market, ending the year with a 6% return.
With the fast and drastic interest rate hikes we saw in 2022, many subclasses within fixed income got hurt. However, now we can look ahead to how fixed income may perform if we see interest rates stay where they are or begin to fall. The best predictor of bond returns over the next decade is the current yield, and today we’re seeing attractive yields in the fixed income market. For example, at the end of 2023, yields in the 30-year treasuries were 4%, investment-grade corporate bonds were 5%, and high-yield bonds were 7.5%! And this showcases the value of a diversified bond portfolio. One of the most common mistakes we see with clients is that they only invest in one type of bond fund!
Something we’re seeing today is attractive yields in the fixed income market. For example, as of September 30th, 2023, we’ve seen great yields in 30-year treasuries (4.9%), corporate bonds (5.5%), and high-yield bonds (9%). And this showcases the value for a diversified bond portfolio. One of the most common mistakes we see with clients is that they only invest in one type of bond fund!
We include bonds in the portfolio as a protective measure if we see another recessionary event like a COVID crisis or valuation bubble because they take on significantly lower risk than equities. Despite the short-term, where owning a 10-year bond in an inflationary period means you're losing a bit of money, over the long-term, we believe bonds can help to cushion portfolio returns and reduce risk by utilizing them in conjunction with a systematic target band rebalancing methodology.
It's essential to diversify your investments across equities, fixed income, and other asset classes since no one knows which asset classes will do well tomorrow.
How Should You Respond In Today's Market Environment?
Managing your exposure to risk is critical in making sure your investments are working for you over time. As the market shifts and you move into various stages of your life, your asset allocation and investment strategy often need to evolve as well. We believe market volatility is becoming a new normal, so managing risk exposure is crucial. If you’re not keeping a close eye on your portfolio, you could be opening yourself up to overexposure in equities or missing buying opportunities.
Rather than becoming overwrought regarding financial issues and reacting frequently to market conditions, it’s important to know how your investment pieces fit together. Understanding their connections and taking a measured approach to your investment portfolio can be key factors in successfully preparing for retirement.
There are a lot of factors involved when it comes to the shift from investing for growth to living off your investments. You want to get it right from the beginning. At Willis Johnson and Associates, we have years of experience helping our clients take emotion out of the equation and positioning them for a successful retirement. Get a second opinion from our experts, who have helped hundreds of energy executives develop the right asset allocation and investment strategy to transition into their retirement and beyond seamlessly.
