Many of us were glad to move on from the dismal market performance of 2022. There was almost no place to hide as even the supposed safe investments in portfolios took a big hit. 2023 has brought welcome relief as the markets have come roaring back and your 401k balances have recovered. At least it feels that way, but has that actually happened?
I was already thinking of this question and then last week a client rightfully was curious about how his portfolio has performed this year. When I gave the number, he wanted to know how this compared to market performance as the number felt low compared to how it seems the market has done this year. It is worth explaining what has been driving your portfolio returns.
There is no debate whether there has been a bounce back in market performance so far in 2023. While 2022 saw higher interest rates being the catalyst for driving down not just stock prices but bond prices as well, 2023 has seen a boost from the AI revolution. The difference is those higher interest rates brought down almost everything in 2022, but AI has not had the same broad based boost in 2023. In fact, only a certain segment of the market has really benefited.
Let’s take a step back and take another look at how bad 2022 really was. Here are some of the major indices and their performance for the year.
Dow Jones: down 8.8%
S&P 500: down 18.1%
NASDAQ: down 33%
S&P midcap 400: down 13.1%
S&P small cap 600: down 16.1%
MSCI EAFE index: down 14.5%
MSCI emerging market: down 20.1%
Barclays US aggregate bond: down 13%
That’s pretty ugly, right? This is your classic diversified portfolio formula: large cap, mid-cap, small cap, international, emerging markets, a mix of growth and value and fixed income. It all had losses on the year. Cash, Commodities, and Energy were probably the best performers last year, and generally, these items don’t make up a very big portion of a typical investment mix, likely not much more than 5%.
And 2023 has been better for sure. If you have been following market activity you are aware that big companies such as Apple, Microsoft, Tesla, Amazon, Google, and Meta have all had great years. So things are great, right? Let’s look at the performance of these stocks.
Those are some pretty amazing results. All are up at least 35% on the year, Tesla has almost doubled, META has and Nvidia, the current king of the AI space, is up over 200% so far. That is why this group has been dubbed ‘The Magnificent Seven’ in 2023. But a closer look at these companies shows that they all occupy a common space in the market; large cap, growth, and say what you will about Tesla, tech companies.
How has this big run impacted the market? When we take a look at the same indices for 2023 year to date performance we get the following:
Dow Jones: up 3.4%
S&P 500: up 15.5%
NASDAQ: up 29%
S&P midcap 400: up 6.8%
S&P small cap 600: up 4.3%
MSCI EAFE international index: up 8.58%
MSCI emerging market index: up 3.1%
Barclays US aggregate bond: down .25%
So the S&P 500 and NASDAQ look good, but the rest? While certainly better than 2022, they are just in line or even slightly below an expected 8-10% return for equities. So what happened to all of the 35% plus returns? As I mentioned earlier, these stocks all kind of fit in the same bucket, large cap growth tech. The issue is that “The Magnificent Seven” only appear in two of these indices and those are, not surprisingly based on performance, the S&P 500 and NASDAQ. Apple and Microsoft are components of the Dow Jones as well but the others are not. According to the Motley Fool as of July 23, these seven stocks accounted for 73% of the gains in the S&P 500. That’s right, 73% from just seven stocks!
According to this data as of August 23rd, only 272 of the 504 (yes, there are currently 504 individual stocks in the S&P 500) are even positive for the year. But the S&P is a market weighted index meaning the bigger the stock valuation of the company, the bigger impact it has on the index performance. And guess which stocks happen to be the top seven market cap stocks in the S&P 500? That’s right, our Magnificent Seven. In fact, those seven stocks make up just over 27% of the entire S&P 500 on their own. As a result, as goes these companies, so goes the S&P 500.
As mentioned earlier, AI has been a boon for this small group of companies and they have continued to record huge profits with positive outlooks for the future. This is a great combination for stock prices. However, many companies continue to struggle with various macroeconomic conditions. High interest rates have brought the housing market to a grinding halt, the rate of inflation has slowed but prices remain high and consumers are having to be more choosy about what to spend money on. And, there is still a lingering cloud of a potential recession in the not to distant future so many companies are hesitant to be too bullish about the coming year. As you might guess, this is not a good combination of things for stock prices.
So, what does this mean for a typical investor? Prudent portfolio management calls for having a diversified portfolio with holdings of various weights likely across all of the indices mentioned above. Holding all of these different investments in 2022 would have helped prevent you from being down 30% last year when a large part of the tech sector fell sharply due to rising interest rates and a correction from the sky high valuations reached at the end of 2021. Depending upon your equity exposure, hopefully, you were down closer to 15%. But this year, that diversification is holding you back.
When looking at a typical 60/40 mix for this year you might be in line for an actual overall blended return of roughly 9%. That’s not bad at all but it is a far cry from the monster returns of the Magnificent Seven and the ETF QQQ which is a decent proxy for the NASDAQ index. If you were expecting those returns across all of your holdings, you are likely wondering why your 401k balance has seemingly lagged. The answer, your diversified portfolio is likely holding a collection of funds, many of which may not have any exposure to the Magnificent Seven and these are watering down your overall returns.
I am not meaning to imply this is a bad thing. Again, this approach helped avoid much bigger potential losses in 2022. If you are young and have the risk appetite then maybe allocating a larger portion of your portfolio to this group makes sense, But, for many investors, risk appetite and where they are on their financial roadmap dictate a more balanced approach.
So going back to the original question. Has 2023 been a good year for the stock market? The reality is it has been a tale of two markets. Large cap tech is enjoying a great year while everything else has honestly just been ok.
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