Defying widespread recession predictions, the S&P 500 stock market index soared an impressive 26% in 2023. As Warren Buffet says, “never bet against America.” That large headline number obscures the narrowness of a market lead by “the Magnificent Seven” (Nvidia, Tesla, Apple, Microsoft, Amazon, Meta/Facebook, and Alphabet/Google). These tech, AI-related companies’ stock prices appreciated an unprecedented average of 111% last year. The Magnificent Seven grew to the largest concentration the S&P 500 has ever had, 29%. The Equal Weight Index only earned 12%. Without the Magnificent Seven, the index would have risen only 8%.
The dominance of these mega-cap firms in technology set a tough stage for diversified strategies. Typically, the largest companies are not always the best companies, and active managers diversify their holdings in attempt to reduce risk. For many, this means including less correlated and historically higher returning asset classes like small cap or overseas equities. In years with large concentrated positive performance, diversification can act as a drag on the portfolio. The Small Cap Russell 2000 returned +17% for 2023, while the overseas MSCI EAFE returned +19%. These returns, typically considered great, lagged behind the concentrated S&P 500. Within Large Cap Equity alone, the S&P 500 ETF index fund “SPY” outperformed the median active manager by the largest amount in two decades.
The Physics of Investing
Sir Isaac Newton introduced the three laws of motion in 1687. Newton’s First Law of Motion states that an object in motion tends to stay in motion unless an external force acts upon it. Drawing parallels with Newton’s laws, momentum is also a potent force in the stock market. An old Wall Street saying paraphrases: “A market in motion tends to stay in motion, until it stops.” Technical analysis is the discipline that tracks these changes in momentum. Traditional investing relies on mean reversion, or the assumption that investments are cyclical and return to the mean. The past year, and the past decade even, seems to have been more technical and momentum based. Looking to the future, estimates from Bloomberg and others predict AI spending to increase between 20-40% a year. Given such, technical factors have strong potential to continue influencing market returns. Equitas Capital Advisors has worked to fuse economic indicators from Ned Davis with technical indicators from Dorsey Wright. This work, expressed by our Navigator series of investments, had its inaugural year in 2023. Please contact us to learn more about our Navigator system available for balanced portfolios, stock only and bond only formats.
Value Hunting
Separate from tech-related growth stocks, value stocks also maintained their momentum of relative underperformance. A retracement of commodity prices, especially the price of oil, has helped inflation normalize to historical levels. Increasing US production, as well as political allowances given to Venezuela and Iran, helped push energy prices down. Energy and mineral equities remain out of favor given the sale price of their outputs, and the market continues to price their stocks at a discount as a result.
Home Country Bias
Given the outperformance of US large cap, both international and other diversified investments created a drag on performance that has lasted about a decade. A longer-term view will show that these categories exhibit more dynamic changes in leadership, roughly divided by decade.
The green bars represent US domestic outperformance, while the blue bars represent International Equities outperforming US stocks. This extremely complex relationship depends on hundreds of factors from currency strength, interest rates, commodity prices, and even wars. The recent AI Tech trend driven by US mega caps has extended the current US dominant cycle. Faster growing economies overseas, changes in both commodity prices and interest rates, and ultimately the strength or weakness of the US Dollar can potentially be an “outside force” that can act on the motion of domestic stock market dominance.
Every quarter, the Federal Reserve releases projections on where they believe interest rates will be in the near future. US rates falling faster than international can provide a bonus to non-dollar denominated investment earnings. Most Federal Open Market Committee members see rates falling, yet remaining near 3%, much higher than the previous average. The Federal Funds Rate, from the beginning of 2008 through the end of 2022, averaged less than 1%. A higher cost of capital will marginally benefit mature and cash flowing companies while putting companies that require large investments to develop new projects, or fund their existing operations, at a relative disadvantage.
To keep closer watch on current economic data, Equitas is proud to launch a new “Research” section of our website at equitas.capital/research, or accessed under the dropdown menu for “NEWS.”
This repository of charts is directly from official sources, and will automatically update on a regular basis. Our first series is on the economic strength of America, of which the consumer comprises roughly 70% of our GDP. From these published charts, the consumer balance sheet and levels of employment remain at historic healthy levels. Noticeably, mortgage rates recently peaked after their highest, sharpest rise in decades. This factor has likely pressured the still normal but quickly changing metrics of rising credit card delinquency and depleting personal savings. This is an active area for us with more dashboards on the way. Please contact us to learn more about our expertise, and if your portfolio is best positioned for your goals and risk tolerance.
In 2002, Equitas Capital Advisors, LLC was established as a unique company that blends the resources of a large global corporation with the flexibility of a small boutique firm. The registered service mark of Equitas Capital Advisors is Engineering Financial Solutions® and the purpose of Equitas is to design, build, and deliver investment solutions to meet the goals and objectives of our investors. Equitas Capital Advisors, LLC, located in New Orleans, has over 200 years of combined investment management consulting experience providing professional investment management services to investors such as foundations, endowments, insurance companies, oil companies, universities, corporate retirement plans, and high-net-worth family offices.