U.S. Equity Investment Environment
U.S. equity markets registered strong gains in the final quarter as the Federal Reserve orchestrated a perceived shift in monetary policy from a “higher-for-longer” stance to possible rate cuts in 2024. The S&P 500 recorded an 11.7% fourth quarter gain to finish the year up 26.3%. The “Magnificent Seven,”—led by Nvidia Corp, Meta Platforms Inc, and Tesla Inc—not only fueled 75% of the S&P 500’s advances but also propelled the Nasdaq 100 to a historic 55.1% gain for the year, its fourth-best annual return. From October to year-end, market performance broadened beyond the seven mega-cap technology stocks with noteworthy comebacks in the real estate, financial, and consumer discretionary sectors. Real estate was the fourth quarter’s top performing sector with its 18.8% gain, helped by expectations that interest rate cuts may be approaching faster than previously anticipated. Falling crude oil and natural gas prices took a toll on the energy sector, which declined 6.9% in the final quarter and finished the year down 1.3%. For 2023, the utilities sector was the weakest, down 7.1%, as investors rotated into “risk-on” assets or fixed income, both of which appeared to offer better risk/reward propositions. With lower interest rates anticipated, small capitalization issues roared back in the final quarter with the S&P 600 registering an impressive gain of 15.1% after lagging the larger capitalization counterparts with its 16.1% gain for the year. Across all market capitalizations, growth stocks outpaced value-oriented issues for another year.
International Equity Environment
International news was dominated by the Hamas attacks of October 7 and the subsequent Israeli retaliation in Gaza. Foreign developed markets underperformed the U.S. with the MSCI EAFE Index rising 10.4% for the quarter and up 18.2% year-to-date. Inflation moderated in the U.K. as the CPI index fell to the lowest level in two years but remained well above central bank targets. The European Central Bank paused its interest rate hikes in the fourth quarter after raising six times, leaving rates at 4.5%. Japanese stocks gained 20.3% in 2023, benefiting from less restrictive monetary policies than other major economies and despite the Japanese yen declining more than 7% against the U.S. dollar. Emerging markets continued to underperform with a modest 7.9% gain for the MSCI Emerging Markets Index in Q4 and 9.8% for the year. China, the index’s largest component, was down 4.2% this past quarter and down 11.2% for 2023, as ongoing worries over its real estate sector and regulatory regime persisted. China ended the year with a smaller index weight of 26.5%, down from 32.3% at the beginning of the year.
Fixed Income Environment
The Bloomberg U.S. Aggregate Bond Index rallied 6.8% in Q4 as the Federal Reserve shifted to a more dovish tone. At year-end, the futures market factored in three rate cuts for 2024. With the Federal Funds Rate at 5.25%-5.50%, the FOMC’s rate-hiking cycle neared its end. Inflation fell to 3.1% in November, the lowest since June 2023. U.S. Treasury yields across all maturities peaked in mid-October with the 10-year Treasury closing the year yielding 3.88%, down from 4.98%, its highest since 2007. The two-and-ten-year Treasury yield spread has narrowed to 0.35%. Importantly, the yield curve inversion has persisted since the summer of 2022 without triggering a recession. In response to lower interest rates, long-dated Treasury bonds rallied 13.2% this quarter to finish the year up 7.1%. High-yield bonds finished the year up 13.4% and municipal bonds also rallied as the Bloomberg Municipal Bond Index advanced 7.9% this quarter to end the year up 6.4%.
Commodities Environment
The S&P GSCI Index dropped 10.7% in the fourth quarter to finish the year down 4.3%. Precious metals have been this year’s top-performing commodity sector, up 11.5%, led by gold, up 12.8% for the year. Energy was the worst performing component, retreating 16.7% on the quarter, despite output cuts by OPEC. Energy prices were driven down most notably by a collapse in natural gas prices, falling 62.6% in 2023.
