2023 Market Recap and Outlook, Bernhard Koepp, C.J.L. 1.3.24

In this video, Bernhard Koepp summarizes 2023 as a year of exceptional performance, but active management needed to catch up with concentrated market gains. As he looks at 2024, calling it a year of potential, he offers advice for a patient and selective approach.

This is Bernhard Koepp from C.J. Lawrence wishing you a happy New Year. Well, it’s been quite a year. 2023 ended with quite a strong market. In this video, I wanted to give you a quick recap of what we experienced last year, what the markets were like, and a quick outlook.

To summarize returns, the S&P 500 had a 26.3% total return in 2023. The NASDAQ tech index was up 44%. Small caps were up only 17%, and the Dow Jones was only up 14%. So, if you were in any equities category last year, you did quite well, even in the international markets. If you look at MSCI Europe, that was up 13%. The German DAX was up 20%. The UK FTSE was up only 3.8%. The MSCI World was up 19.5%, driven a lot by Japan, which was also up a lot.

Even if you were in fixed income, if you look at things like the US Aggregate Bond ETF, it was up 5.65%, and the investment grade Corporate Bond ETF was up 9.4%, almost double-digit returns for 2023. So quite a year! It’s surprising to many, given how negative the sentiment was going into 2023, and most strategists and economists didn’t get it right.

If you look at interest rates, that’s also incredible. Looking at the 10-year treasury, we began with a yield of 3.9% at the beginning of last year and ended exactly at 3.9%. So we came full circle.

If you look at the trajectory of the yields during the year, in the March period, which was just in the epicenter of the mini-banking crisis, where we saw three banks going bust, yields actually went down. That was a bit of a head fake. We thought, including myself, that it was signaling a top in yields. But after that, we saw yields dropping to 3.3%, but then we saw yields going up all the way to 5% above the previous peak, which was around 4%. And that came to an end when the Fed finally pivoted. That was something that was highly signaled and anticipated. When we got the pivot, markets really took off. It’s not just the equity markets but also the fixed-income markets. You saw yields going from 5% on the 10-year down to all the way to 3.9%, which is where they are now.

You saw the same thing in the two-year treasury. That started the year at 4.4%, went down to 3.8% during the banking crisis, went up to 5.24% roughly at the high end in October when the Fed signaled its pivot, and today it’s back down to 4.2%. That’s quite a move in fixed-income markets, and it set up a decent rally in equities in the seasonally strong months of November and December.

That also coincided with a peaking of the dollar. You had the dollar selling off going into the end of the year, which is a relief to companies that derive many of their earnings or revenues from abroad. If you think about many of the debts tied to the US dollar abroad, that provides some relief to US dollar-denominated debt, which is in international markets and sovereigns.

It’s been a tough year for active management, and there are a couple of reasons why. One was the dominance in the US markets of the magnificent seven stocks. Tshese were seven incredibly large-cap stocks, typically technology and communication stocks, that were up in incredible amounts. If you think about stocks like Nvidia, they were up over 200%. Stocks like Meta were up almost 200%. The more pedestrian performance out of things like Apple and Microsoft were only up between 50 and 80%. These were incredible moves, but they also came on the heels of a very weak and depressed 2022.

You saw a massive relief rally in these kinds of large-cap stocks, and those were largely driven by fundamentals. If you think about the product cycles that were underpinning this, generative AI is something we’ve talked about a lot that certainly drove the communication sector and the technology sectors. We continue to watch that with a lot of optimism when it relates to generating revenue and earnings growth.

It’s interesting that in 2023 if you ran a highly diversified portfolio, that did not help. In terms of generating alpha, being highly diversified did not help.  What made the difference, whether you beat the index, meaning either the S&P 500, which was up 26% or any other index like NASDAQ, it was all about how many of the magnificent seven stocks you had in the portfolio. For our portfolio, for example, we own six of the seven. We love those businesses. We do not think those businesses are terribly overvalued. Given the 30 years we’ve been doing this, we’ve seen periods, especially in the late ’90s, where we’ve seen much higher valuations on technology stocks in particular. That is not something we’re seeing this time. A lot of the multiples are really based on the higher valuations, and PE Multiples are based on sustainable businesses that have sustainable revenue growth and earn per share growth.

Looking at just turning the smart money, hedge funds were only up 6.6% last year. So it was good to be long-only. It’s interesting if you look at the statistics on equity ownership; if you look at, again, the smart money, which are the endowments, they only had about 28% in equities going into 2023. They were quite under-owning the long-only equity portion. They had increased a lot of their investments in alternatives. And it’s interesting how once the Fed signaled its pivot; you saw a lot of that money coming back into the equity portion of the market.

It’s also interesting if you look at households. The participation of retail investors or households is really at an all-time high. 60% of households today own equities. That’s quite a high number. You may remember that back in the ’80s, that number was more like 30%. So, twice as many households today own equities in their portfolio or are exposed to equities as opposed to some 20 or 30 years ago.

Let’s turn to Outlook. Typically, when you get a big up year like last year, it’s followed by another positive year because you get this effect where people are playing catch-up, and usually, the last remaining bears or retail investors who missed a lot of this play catch-up. You see a lot of momentum coming back to the market. That’s something to be expected coming into 2024. Looking at the interest rate cycle when the Fed signaled its pivot, the market is expecting at least two or three interest rate cuts in the second half of this year.

A lot of that positive news is priced into the market today, but I think it’s quite clear any dip you would get in the market, so any pullback that we would see in January or in February at the beginning of this year, where tax selling is less of a factor than it was in November or December, you will see new money coming in. As we said, the endowments are underinvested in equities, and you see retail investors piling in to buy that dip. So we think that is a good strategy both on the equity side and bond side at this point when interest rates peak and there is this expectation that interest rates will be lower in the future. Owning longer-duration bonds is something that could be very profitable going into the next couple of years. That balanced portfolio that hasn’t worked in previous years is something that should be looked at again, and your typical 60-40 portfolio is something that will probably generate decent returns, also on the fixed income side, which is something we haven’t seen in many years prior to 2023.

The market, as I said, has come a long way. So we have to be patient. If we’re going to put new money to work, we wait for a dip. In terms of sectors, look, we still like technology. The secular growth drivers in the technology sector have many years ahead. We think the benefits of Cloud computing and now the applications and software as a service that are being turbocharged by generative AI – it’s just at the beginning. And the big difference, as I’ve said in previous videos that we’ve seen in this technology cycle versus the one in the 1990s, is that real revenues and earnings per share are connected directly with the rollout of these new technologies.

In the ‘90s we did not have that. We had a lot of companies that were changing their name from X and putting dot-com on their name, but there were no revenues associated with that new technology. It was basically clicks. And when that came to an end at the end of the ’90s, valuations collapsed, and we had a three-year market after the end of that cycle where you had negative returns. We don’t see that, because if we’re looking into the future, estimates for earnings per share growth are double-digit going into 2024 and 2025. That may still be a bit high, given we’re seeing a slowdown in macro activity, but that does set up a pretty decent equity market for 2024 and puts a floor under valuations. There was this notion that valuations were going to collapse, one because of these higher interest rates and two because of a severe recession. Both of these issues are now off the table. We can look at more of a stabilization of these price-to-earnings ratios.

Again, we said we still like technology but also select healthcare. The big growth driver in the healthcare space has been these GLP-1 drugs. This is this new glucose medicine that basically not only treats things, such as your blood sugar levels, but it also reduces weight, which helps in everything from heart disease to the danger of having a stroke. All of these things are very much embedded in that technology, and we’re seeing that playing out in two of our stocks, which are Eli Lilly and Novo Nordisk. But there’s going to be a lot more related to that class of drugs going ahead.

Industrials is another area that we’ve spent a lot of time on in the last couple of weeks. That has been out of favor in terms of the macrocycle, but the valuations on the industrial side look very attractive.  Also with financials – banks and industrials are two value sectors that are quite attractive here in this cycle as the Fed starts thinking about lowering rates and orchestrating and engineering this so-called soft landing.

On the secular growth side, on the industrial side, we are seeing a lot of reshoring. My partner, Terry Gardner, has written and spoken about this a lot. There is a secular growth trend happening in companies like Rockwell Automation where new technologies are allowing us to reshore production in typically high-cost, labor-cost type markets like the US, to better our supply chains. We’ve learned in the aftermath of the pandemic that it’s better to produce things closer to the shore and the technology, that really strong technology that is behind all this move, that is allowing us to create this production on shore.

To sum it all up, there is still this notion that we may go into a recession in 2024. We could get one or two quarters of negative GDP growth. That’s not out of the question, but I think the consensus is now that that will be very shallow. If you think of earnings per share growth, it shouldn’t affect most stocks in terms of the severity of that recession, and we’re seeing relief now on the margin side, that’s profit margins from lower interest rates going forward. We’re also seeing it for the consumer. It’s incredible how the consumer has been very, very strong. We’re seeing a bit of a wealth effect. Typically, when you get a strong stock market, you also get a strong consumer. We saw that in the fourth quarter.

Mortgage rates after the great financial crisis in 2008 and 2009, I think many mortgage holders and individuals who hold mortgages have realized it’s better to lock in a low mortgage longer term rather than play with the short-term volatility of mortgage rates. So we’ve seen mortgage rates come down, so the refinancing risk if your mortgage expires in the next year will be a bit easier. Mortgage rates have come down from a peak of about 8% to about 6% now, and I would not be surprised if that continues. That will help the housing market, which has certainly had a slowdown.

When we look at GDP growth, we’re looking at the forecast of many of our good friends on the macro side. If we get a low growth environment, let’s say 2%, which is our base case, that sets up a pretty decent market for our investment discipline, which tends to emphasize more growth stocks. Typically, growth stocks get a premium valuation when GDP growth is slow but steady.

With that, we’re wishing you a great 2024. We thank you for your support and look forward to seeing you in the new year. Take care.


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