2023: The Year in Charts
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Here are the charts and themes that tell the story of 2023…
I. The Wall of Worry
The wall of worry was a mile high entering 2023.
Why?
Stocks had just suffered their worst year since 2008 (S&P 500: -18.1%) while bonds had their worst year in history by a wide margin (10-year Treasury: -17.8%).
At the top of the list of fears: a recession, which nearly everyone was anticipating…
The myriad of other concerns included an inflationary spiral, rising interest rates, falling earnings, the war in Ukraine, and the Fed’s ongoing tightening of monetary policy.
And so the wall of worry had been built, with:
- a) the longest streak of negativity in retail investor sentiment that we’d ever seen,
- b) the most persistently negative US consumer in history, and…
- c) the fact that perennially-bullish Wall Street strategists had turned bearish for the first time (predicting a down year for stocks).
Another dismal year for markets was in the cards, or so it seemed.
II. The Pain Trade
And then, the unexpected happened.
After the first few trading days, stocks began to rise.
And rise.
And rise some more.
There’s an old saying that the market has a tendency to cause the most pain to the most participants and given the prevailing sentiment, the pain trade was clearly up.
By early February the S&P 500 was off to one of its best starts to a year in history.
But as earnings season unfolded, many of the concerns investors had entering the year came back into focus, with stocks giving back some of these gains. For the 3rd straight quarter, S&P 500 companies reported negative growth, with the 27% YoY decline in Q4 2022 being the largest since the 2020 recession.
But falling earnings were a risk that investors were well aware of entering the year, and didn’t come as a huge surprise. What would take the market down further would have to be something unexpected – something like a run on the bank.
III. A Run on the Bank
Before March 2023, it had been quite awhile since we heard anything at all about bank failures. And for good reason: there were exactly zero failures in 2021/2022 and only a few small ones in the five years before that.
But all that changed in a big way over a few days in March 2023 when both Silicon Valley Bank (SVB) and Signature Bank were shut down.
It was a classic run on the bank, with depositors racing for the exits, attempting to withdraw an astounding $42 billion from Silicon Valley Bank in a single day.
The big question at the time: what would happen to the many depositors who had accounts at these banks above the FDIC insurance limits?
We didn’t have to wait long to find out. SVB failed on Friday, March 10 and by Sunday night on March 12 the Treasury, Federal Reserve, and FDIC issued a joint statement guaranteeing deposits at both SVB and Signature. At the same time, the Federal Reserve provided a massive amount of liquidity to the banking system via the new “Bank Term Funding Program (BTFP).”
The “Fed put” that had been on hiatus since 2020 was suddenly back in action.
This swiftly quelled fears of a contagion and “another financial crisis.” After giving up nearly all of its gains on the year, the S&P 500 would bottom the very next day (March 13) and never look back.
In early May, a third regional bank would fall (First Republic), but the broader equity markets barely seemed to notice. Another bailout of uninsured depositors was rapidly put into place and JPMorgan Chase received an absolute windfall in taking over First Republic for next to nothing. Thus, the largest banking institution in the US became even larger, and the too-big-too-fail unwritten rule become even stronger.
By the end of the year, the 2nd, 3rd, and 4th largest bank failures in history had long been forgotten, with our memories erased by the rising tide that would follow.
If someone had told you that the total assets of failed banks in 2023 ($548 billion) would exceed 2008’s record total by $175 billion, you would probably have assumed that it would have been a disastrous year for markets. But as we would learn once again: every time is different.
IV. A Different Kind of Fed
Speaking of different, the Fed’s policy reaction to the banking issues was completely out of character.
Back in 2008 and 2020 when bank stocks saw similarly large declines, the Fed was rapidly cutting interest rates down to 0% and doing massive amounts of Quantitative Easing (QE).
In stark contrast, the Fed stayed the course in 2023 and continued to tighten.
All told, they increased the Fed Funds Rate another 100 bps during the year, with 25 bps hikes in February, March (after the SVB failure), May (after the First Republic failure), and July.
That brought the total spike in rates over 2022-2023 up to 525 bps, the largest 2-year increase since 1979-1980.
The Fed Funds Rate now stands more than 2% above Core PCE (the Fed’s “preferred measure of inflation”), the most restrictive monetary policy we’ve seen since October 2007.
And cash (3-month Treasury bill) had its highest year-end yield (5.40%) since 2000.
On the balance sheet front, the Fed continued to tighten as well, with the largest calendar year decline in assets ever, both in terms of dollars (-$838 billion) and percent (-9.8%).
This tight policy bias, however, is not expected to last much longer. During their December meeting, the Fed projected 3 rate cuts in 2024 and the market is pricing in even more dovishness with 6 cuts. But a lot can change between now and March when the rate cuts are expected to commence. And as we’ve learned time and again over the last decade, both the market and the Fed are often very wrong when it comes to predicting the direction of interest rates.
V. AI Exuberance
The financial markets are ultimately the real-time reflection of how investors are interpreting millions of different stories. When the story is deemed to be positive, prices rise. When the story is deemed to be negative, prices fall.
A very small subset of these stories rise to the top and are so compelling that they can influence the sentiment of the masses. Artificial Intelligence (AI) was that story in 2023, and it brought with it all the hope and promise for the future that any great story entails.
It started very early in the year when ChatGPT became the fastest product ever to reach 100 million users.
Everyone was talking about it and it didn’t take long for Big Tech to catch on, with earnings calls dominated by mentions of “AI.”
And then there was Nvidia ($NVDA), the story stock of 2023, which transformed the AI boom into a full-fledged mania. In their first quarter report, Nvidia exploded higher after giving forward guidance that was 50% higher than Wall Street estimates.
That guidance underestimated the exponential growth to come, with Nvidia’s revenues surging to a record $18.1 billion (+206% YoY) by the 3rd quarter and Net Income to a record $9.2 billion (+1,259% YoY). Illustrating its tremendous pricing power, net profit margins exploded higher as well, moving above 50%.
Nvidia would join the trillion-dollar club in May and end the year with a market cap of $1.2 trillion.
With a gain of 239%, it was the top-performing stock in the S&P 500.
VI. The Magnificent Seven
Nvidia was the band leader of a group of stocks that became known as “the Magnificent Seven,” and what a year it was for these seven companies. All seven stocks recovered from brutal declines in 2022 to outperform the S&P 500 in 2023 by an enormous margin (Apple was the lowest performer of the group with a gain of 49%).
These incredible gains boosted their weighting in the S&P 500 from 20% to 28% over the course of the year, which was the largest share for any 7 companies in the index on record (with data going back to 1980).
Incredibly, the Magnificent Seven now have a higher weighting in the MSCI World Index than all of the stocks in the UK, China, France and Japan combined.
The big question for investors going forward: are expectations too high?
The Magnificent Seven stocks are trading at a forward P/E ratio of 33x versus 21x for the remaining 493 companies in the S&P 500.
VII. The Sky’s the Limit
Speaking of “too high,” that’s what many of us said about US National Debt during the so-called “debt ceiling crisis.”
But the ceiling was removed as it always is, and National Debt moved higher as it always does. The one constant is more debt and there seems to be no sense of urgency to do anything about it. That’s because the primary objective of most politicians is to keep their job, and they do that by promising to spend more and more money.
They made good on those promises and then some in 2023, with the US National debt exploding higher to the tune of $2.5 trillion in the final seven months of the year. To say the US government is spending money like a “drunken sailor” would be an insult to drunken sailors who at least a) spend their own money and b) quit when they run out of funds.
National Debt would cross above $34 trillion by the end of December, over $12 trillion higher than where it stood just five years earlier (55% increase).
And all of this debt is becoming increasingly costly to service, with the Interest Expense on US Public Debt rising to $949 billion, another record high. If it continues to increase at the current pace it will soon be the largest line item in the Federal budget, surpassing Social Security.
VIII. The Recession That Never Came
In a year filled with surprises, the recession that never came was at the top of the list.
Real GDP in the US was above 2% annualized in both Q1 and Q2, and jumped to nearly 5% in Q3.
That brings the US economic expansion to 41 months and counting, with most now expecting it to continue for at least another quarter.
The biggest factor helping keep the economy afloat?
Continued strength in the labor market, with jobs growth in every month of 2023 and 36 months in row.
The U.S. Unemployment Rate hit its lowest level since 1969 in April (3.4%) and ended the year at an impressive 3.7%.
We’ve now seen an Unemployment Rate below 4% for 23 straight months, the longest streak since the late 1960s.
IX. The Earnings Comeback
The earnings recession that began in 2022 was widely expected to continue in 2023.
But market participants did not appreciate how rapidly companies would adapt to changing conditions. The S&P 500 returned to positive year-over-year earnings growth in Q1 (+5% YoY) and followed that with upside surprises in Q2 (+14% YoY) and Q3 (+7% YoY).
On a trailing 12-month basis, operating EPS for the S&P nearly hit a new high in Q3, and are expected to make a full recovery of the 2022 dip when 4th quarter earnings are released.
Remarkably, not only did the S&P 500 P/E multiple not contract as many expected in 2023 but it actually expanded by 14%. Trading at 22.3x earnings, the S&P 500’s valuation is now above the historical average of 19.3x since 1989.
X. The Frozen Housing Market
At the end of 2022, all signs were pointing to a sharp decline in home prices, with sky-rocketing mortgage rates leading to a collapse in affordability.
But that decline never materialized even though mortgage rates would move even higher (2023 peak of 7.79%, highest since 2000), and affordability would move even lower.
Only 16% US homes for sale in 2023 were affordable based on median incomes, the lowest share on record.
The median American household would need to spend 44.7% of their income to afford the median priced home, a record high.
Why didn’t this translate into lower prices?
While demand indeed collapsed, supply collapsed even more, and that lack of inventory not only supported prices but boosted them.
Why are inventories so low?
62% of US mortgage holders have a rate below 4% and 92% have a rate below 6%. With current mortgage rates at 6.6%, many existing homeowners are staying put, leading to a dearth of homes for sale.
That in turn has lifted the average price a home in the US to new record highs.
With few buyers able to afford those lofty prices, transactions plummeted to their lowest levels since the global financial crisis. Until this dynamic changes, we have a housing market frozen in time.
XI. Back on the Path to Prosperity
The inflationary spiral of 2021-2022 was expected to continue to cause problems for markets in 2023.
But instead, we saw a steady move lower in inflation throughout most of the year, with headline CPI ending at 3.1% and core CPI below 4% (lowest since September 2021).
Excluding shelter (which remains elevated due to its extremely lagging nature), prices rose just 1.4% over the last year, the 6th consecutive month below 2%.
The decline in inflation over the past year was a global affair, with nearly every country showing a lower rate today than a year ago.
After a record 25 consecutive months of negative real wage growth in the US, wages have now outpaced inflation on a YoY basis for 7 straight months. This is a great sign for the American worker. We are back on the path to prosperity, and hopefully this trend continues.
XII. A Rally for the Ages
Investment returns are anything but linear, and we witnessed that in dramatic fashion to end the year. November and December 2023 will go down as one of the strongest back-to-back months for financial markets in history:
- The S&P 500’s 13.9% gain was in the 99th percentile, good for 12th place since 1950.
- The Bond Market’s 8.5% gain was the best two months since September-October 1982.
- The 60/40 portfolio of US stocks and bonds gained 11.9%, its best two months since March/April 2009 and 5th best since 1976.
XIII. The Polar Opposite of 2022
2023 was in almost every way the polar opposite of 2022.
Growth stocks outperformed Value stocks in 2023 by 31%, the 2nd biggest outperformance on record with data going back to 1979 (only 2020 was bigger). In 2022, they had underperformed Value stocks by 21.6%, the most since 2000.
The S&P 500 outperformed the equally weighted index by 12%, the 2nd biggest outperformance on record with data going back to 1971 (only 1998 was bigger @ 16%). In 2022, the equal weight index had outperformed by 6.7%, the most since 2010.
US stocks (S&P 500) outperformed international stocks by 7.7% in 2023 after underperforming by 4.3% in 2022.
The top three sectors in 2022 (Energy, Utilities, and Consumer Staples) were the bottom three in 2023 while the bottom three sectors in 2022 (Tech, Communications Services, and Consumer Discretionary) were the top three performers in 2023.
After suffering its worst year in history in 2022 with everything lower except for cash, all segments of the global bond market finished higher in 2023.
Credit-sensitive areas (Leveraged Loans, High Yield) led the way as spreads tightened and default expectations declined, the opposite of what occurred in 2022 (spreads widening, rising default expectations).
XIV. Triumph of the Optimists
There was no shortage of things for investors to worry about entering 2023, but by the end of the year that wall of worry had been completely torn down.
No chart illustrates this better than the AAII investor sentiment poll.
In December 2022, Bears outnumbered Bulls by 32% and one year later Bulls outnumbered Bears by 32%.
What changed?
Rising prices. It’s counterintuitive, but investors always seem to get much more positive and excited about the future when prices are rapidly rising, which is the exact opposite of how they should be feeling (long-term investors should be more excited to buy when prices are rapidly falling). But no one ever said investors were rational.
Against all odds, the Dow ($DIA), S&P 500 ($SPY), and Nasdaq 100 ($QQQ) ETFs all hit a new total return high in December 2023, completely recovering from the 2022 bear market.
The S&P 500 ended the year up over 26% on a total return basis, erasing the loss from 2022 (-18%).
And it achieved this high return in spite of the fact that there was a drawdown during the year of over 10%, proving once again that risk is not an impediment to reward but the underlying reason for it.
After losing 1.5% in 2021 and suffering their worst year in history in 2022 (-13%), US Bonds moved back into positive territory with a respectable gain of 5.5% in 2023.
The US 60/40 portfolio which had been declared dead by many rose 18%.
With a gain of 56%, Technology stocks led the US market higher. This was the biggest gain for the Tech sector since 1999.
The top 4 stocks in the Dow (Salesforce, Intel, Microsoft, and Apple) were all in the tech sector, helping the Dow hit a new all-time high for the 11th straight year.
Every major asset class moved higher in 2023 with the exception of Commodities. But the decline in Crude Oil and other commodity prices was not a true negative as it served to alleviate two big fears (inflation & further Fed tightening).
Speaking of fear, the Volatility Index ($VIX) moved all the way down to 12 in December, its lowest level since 2019.
The S&P 500 would end the year at 4,770, besting every major Wall Street firm’s price target by over 200 points. The S&P 500’s actual price gain of 24% was over 18% higher than the average forecast. All in all, it was a triumph of the optimists once more.
XV. What Comes Next?
Those were the charts and themes that told the story of 2023. As always, the narratives followed prices.
As prices change in 2024, the narratives will surely change as well.
- Where will the S&P 500 end 2024?
- How about the 10-Year Yield?
- Where is Crude Oil headed?
- Is Gold or Bitcoin a better investment today?
- How many times will the Fed cut rates in 2024?
- Will inflation continue to move lower?
- When will the economy fall into recession?
I don’t know the answer to any of these questions.
As Lao Tzu said, “those who have knowledge don’t predict. Those who do predict don’t have knowledge.”
What’s the alternative?
Weigh the evidence as it comes, invest based on probabilities, be forever humble and thankful, and leave the predictions to those whose job it is to entertain. That’s the best you can do in this fickle business of investing – try to find the right path for you and stick with it long enough to reap the enormous benefits of compounding.
In 2024, I predict one thing and one thing only: you will see many more surprises. That is the nature of markets.
I wish you all a happy, healthy, prosperous and fulfilling 2024.
If we can help you on your road to wealth, reach out.
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