Happy New Year! From everyone at Ratio Wealth Group, we wish you and your loved ones a healthy and prosperous 2024.
As the year ended, I went back to our previous quarterly communications to see where our directional commentary might have been additive and where we might have been off the mark in our observations. This is always an interesting exercise. Last January, we mentioned a “Wall Street” consensus forecast of a modest 4% increase in the S&P 500, for 2023. I also wrote that there are two types of forecasters in the world… those who don’t know, and those who know they don’t know, humbly adding that we at Ratio identify in the latter category. The S&P 500 finished the year up ~24%.
Large companies to small companies, growth to value, US to non-US, all were positive in 2023. Even the pain that was felt in the bond market during 2022 reversed course. Fixed income is now seemingly back to its boring, old self of pre-2008 levels, an asset class to complement a balanced portfolio where volatility is tempered, and healthy yields are available. What a novel, but welcome concept.
While market participants breathed a healthy sigh of relief over the last year, let us focus on where the camps of “hard” landing and “soft” landing missed the mark. Part of the fuel that pushed account values higher was that neither of these scenarios really played out. The current reality could be described as barely a “touch-and-go” or no landing at all. Inflation is now palatable, GDP expanded at its fastest rate since the fourth quarter of 2021, and with interest rate relief on the horizon, maybe, just maybe, normalized economic growth is possible.
While we all want to look towards the future, some reflection can be a valuable tool and a reminder for investors not to get consumed by short-term performance. Headlines all year identified the major driver for the S&P 500 in 2023 as the Magnificent Seven (Apple Inc., Microsoft Corp, Amazon.com Inc., NVIDIA Corp., Alphabet Inc., Meta Platforms Inc., and Tesla.) In 2023, these stocks had an average return over 100% and accounted for 62% of the S&P 500’s total return. Impressive! Without this group, the index return was just under 10% (Source: S&P Dow Jones Indices – January 3, 2024, U.S Equities Market Attributes December 2023).
Now let us zoom out. For the trailing two-year period, these seven names are up only 2%, or a whopping 1% annualized. When added back into the S&P 500, the index is up a little over 3%. Small and mid-cap US companies, as measured by the S&P 400 and S&P 600, are down 2% and 6% respectively, over the last two years. All world indexes are similarly off, down around 5% (ACWI All World Index). Even the bond market’s return to glory still has a lot of ground to make up to get back to 2021 levels (the US Aggregate Bond Index is down 13% over the trailing two-year period).
This observation is not meant to be anything other than witness to a wild ride since the COVID pandemic. A pandemic that led to massive stimulus in the form of cheap money, that led to weird supply chain issues, that among other things, led to inflation not seen since the 1980’s, that led to aggressive rate increases, that led to recession fears, that led to an essentially flat 24 months, where we might have been able to skirt total capital market collapse after all. It also serves as a reminder that diversification, and not trying to time the market, wins over time.
With all that said, and all that chaos behind us, the US economy appears stable and broad valuations seem reasonable, relative to modest growth expectations. With the Federal Reserve recently suggesting rate cuts as early as March, investors started to rebalance portfolios and reposition some of the nearly $6 trillion sitting in money market funds. Diversification that did not help early in 2023, began to work as the year ended. Non-Magnificent Seven, smaller US equities and non-US equities, all saw double-digit returns in the fourth quarter.
Ratio’s investment team used the last three months of the year to slightly shift weightings down in market cap, based on large valuation spreads and our year-long belief that a recession was avoidable. We also added to fixed income allocations during the back half of the year, based on attractive yields farther out on the yield curve. We are optimistic for a healthy investment environment in 2024 driven by the factors mentioned above. We remain committed to customizing your investment allocations to produce the best risk-adjusted returns to support your long-term planning objectives.
One common strategy we recommended early in the year was to take advantage of money market rates in the 5% range for fixed income allocation and liquidity needs. This was a sound strategy as an aggressive Fed made short-term cash equivalents a viable investment option for the first time in years. As indicated, the Federal Reserve is now expected to lower the overnight interest rate several times in 2024, as their fight against inflation is coming to an end. US labor demand has also softened slightly, giving additional hope for sustained lower inflation. Money market yields will fall in step with these interest rate cuts, so now is the time to reassess cash and bond allocations.
We will be working with those of you who have larger allocations to money markets to strike a balance between near-term liabilities (an upcoming purchase, or monthly outflows to fund ongoing expenses, for example) and long-term returns, with appropriate risk. Based on your individual needs and risk tolerance, we anticipate further increasing holdings in intermediate-term fixed income and equity assets that will benefit from the upcoming interest rate cuts.
For those seeking lower volatility, excess cash can go into bond funds and bond ladders, where we can now lock in higher yields. For clients with longer-term horizons and the ability to weather temporary market troughs, our globally diverse equity ETF models provide the long-term growth necessary to outpace inflation and build wealth. The market values of both stocks and bonds generally go up as interest rates drop, while money markets are always priced at $1 per share. Staying in cash, in hopes of entering the market at a lower price point in the future, is a form of “Market Timing”, a strategy that has historically underperformed our preferred strategy of “Dollar Cost Averaging” (the practice of systematically investing at regular intervals).
You hopefully notice that I sign off with a recognition of gratitude. We all remain grateful to be a trusted resource on matters that hold such crucial importance to each of you. Whether you are in the early stages of saving, or you have worked hard and just don’t want to mess it up before your pending retirement, our dedicated group of very experienced planners and investors is here to support you in 2024 and beyond.