US Markets: After a turbulent 2023, US markets are taking a moment to catch their breath.
But let’s not get carried away too much.
Even after the 2023 rally, most stock investors have barely gotten out of the water after early 2022. It looks even better if you include dividends. The S&P 500 then returned 3.42% over two years. Nonetheless, the weak stock market gains have not kept pace with inflation.
If you can bear the pain, remember the simultaneous declines in the stock and bond markets that made 2022 a terrible year for investors. The situation was much worse than the stock market crash during the 2008 financial crisis. While bond values fell sharply in 2022 as interest rates rose, investment grade bonds rebounded as interest rates fell during the financial crisis.
Lately, the market has become much friendlier to investors, with both stocks and bonds holding their own.
The strong returns in 2023 are due in no small part to the stellar performance in the final three months of the year, driven by growing expectations that the U.S. economy will avoid a recession and that the Federal Reserve will soon begin cutting interest rates. Periodic interest rate.
The final quarterly and annual figures for 2023 were exceptionally good. This translates into significant annual gains for the millions of investors who often hold stocks and bonds indirectly in their workplace retirement accounts, through mutual funds, exchange-traded funds and trusts. So, if you have broad, diversified investments that track the market, survive the recession in 2022, and persevere through 2023, you’re probably going to be fine. It may be slightly ahead of where the portfolio will be in early 2022.
good news
Let’s look back on the good times at the end of 2023.
The S&P 500, which tracks the most valuable stocks in the U.S. market, rose 11.2% last quarter and delivered a total return of 11.7% including dividends. This year, including dividends, the rate of return was 24.2% and the rate of return was 26.3%.
Broader U.S. stock indices such as the Russell 3000, FT Wilshire 5000, and Dow Jones US Total Stock Market Index (which includes small caps and the giants of the S&P 500) also had total returns of about 26% in 2023. .
Regular fund investors shared most of these gains, according to a database maintained by financial services firm Morningstar. The average rate of return for U.S. domestic stock mutual funds and exchange-traded funds was 11.3% in the fourth quarter and 20.3% for the year.
The average fund lags significantly behind the overall stock market average. Most funds are actively managed by professionals who strive to beat the market. In contrast, broad, low-cost index funds that simply try to reflect the market have generally done their job well.
For example, the Vanguard Total Stock Market Index Fund returned 12.3% for the quarter and 26.1% for the year, outperforming the average fund as well as the S&P 500. Simply put, this is why I believe it’s better for most people. Use cheap index funds.
Most global markets also performed well in 2023 and, as usual, average funds trailed market returns. For example, the MSCI All Country World Index (also known as ACWI), an important global benchmark, returned more than 21% in 2023. The average international fund in Morningstar’s database was just 14.3%.
Of course, some individual stocks performed much better than average. Nvidia, which makes advanced computer chips, is up 239% in 2023. Facebook’s parent company Meta rose 194% after falling 64% a year ago amid investor skepticism about the company’s focus on the so-called metaverse. But in 2023, these big tech stocks benefited from the artificial intelligence craze, sending the S&P 500 higher. Perhaps more surprisingly, cruise lines have also proliferated. Royal Caribbean is up 162% and Carnival is up 130%. If you had focused on one of these stocks in early 2023, you would have been a winner.
And again most stocks performed below average. Major S&P 500 stocks Dollar General, Moderna and Estée Lauder are down more than 40% in 2023.
Stock selection and market timing are difficult and time-consuming. I avoid both practices and pursue completely average market returns that are better than what most active traders get.
ongoing bond losses
The situation for bonds also improved, but with an important caveat. Many people who have traded bonds or held bond funds since early 2022 have yet to recover their losses.
Those who bought and held individual investment grade bonds did well in 2022, but the performance of bond funds was not nearly enough to make up for the previous year’s decline.
If interest rates rise, as they will in 2022, bond prices will fall. Bond fund returns are a combination of income and price fluctuations, and in 2022, the price decline was much larger than the income.
Fortunately for investors, that changes in 2023. The Bloomberg US Aggregate Bond Index, widely followed as a benchmark for investment-grade bonds and core bond funds, has returned 5.5% this year, according to FactSet. But the losses in 2022 were so large that the aggregate bond index was still down 8.2% over two years, as were many bond funds.
The situation was even worse for long-term bonds. Because of the way bond math works, when interest rates rise, short-term bonds lose more in price than short-term bonds. One alternative to long-term bonds, the iShares 20+ Year Treasury Bond ETF, is up 2.8% in 2023 but is still down more than 29% over the two years combined.
The world of bonds is huge. We will discuss this again in a future column. But the lesson here is that bond funds are generally more stable and safer than stock funds, but not always. It depends on the time of investment and the bond.
Now what?
Interest rates, inflation, and economic strength are key factors for both stocks and bonds. It would be good to know in advance how this will all play out.
But we don’t know, and no one predicts well enough to rely on these predictions for our investments each year. Fortunately, you don’t need to know what’s going to happen in the world in the next few months or years to be successful as an investor.
From a more long-term perspective, I would say that what we have experienced over the past few years is very similar to mean reversion, i.e. the market returns to its customary long-term upward trajectory after a terrible ordeal. Expect more: If it has the strength to hang on through the tumult, it will deliver cyclical market downturns, interspersed profits, and significant returns for long-term, low-cost buy-and-hold investors.
I base that argument on history. Including the final count in 2023, the average annual return for the S&P 500 since 1926 was 10.4%. This means that on average it took less than seven years for the U.S. stock market to double in value.
It’s not clear that we’ll get that kind of return in the future. It certainly can’t be pain-free.
Because there are no guarantees, as many older readers have pointed out, this decades-old strategy won’t work when your horizons are short. In such circumstances, securing returns at the relatively high interest rates currently prevalent makes more sense than the long-term “set it and forget it” approach.
Whatever your investment horizon, enjoy the better times in the market, but be cautious. The losses in 2022 were a vivid reminder of how important it is to set up your portfolio to withstand market pain. I hope the current calm will continue. But be prepared whenever something goes wrong.
