Perspective :

Fourth Quarter 2023 Capital Markets Perspective

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A wondrous year, a curious time

December’s 4.5% gain for the S&P 500® capped a run sufficient to erase the losses from 2022, bringing the Index’s two-year annualized return to 1.7%. Thanks are owed to the Magnificent Seven[1], which contributed about 16% of the Index’s 26% gain for the year (the tricky math says the rest of the Index supplied the other 10%). Bonds likewise enjoyed a strong finish, gaining 3.7% for the month, 6.6% for the quarter, and 5.3% for the year, but remained underwater since the beginning of 2022 given the steep losses suffered that year. The only major asset class that finished in the red for 2023 was commodities, which slumped as inflation eased, retreating by almost 8%. Yet despite the strength in capital markets, not all was well on Wall Street. DealBook reported that global M&A fell to a 10-year low and that IPOs tumbled by 25% year-over-year, with total proceeds hitting a 14-year low. So, while investors can and should celebrate 2023, they might want to take a moment to remember the less fortunate – the downtrodden class that makes up the investment banking ranks.

And what of the year ahead? Well, economists and market strategists were so spot on about what 2023 held for the economy and the markets that we can probably bank on the roughly 6% gain for the S&P 500 implied by the median year-end 2024 forecast, according to FactSet. We’ll add that one of the interesting, albeit less-than-useful facts about presidential election years is that the S&P 500 has risen on average by 11% since 1952. Perhaps more intriguing is the fact that investors are expecting five or six rate cuts this year, which is far in excess of what policymakers have been telegraphing, and seemingly premature in the face of year-end economic data.

To that point, while employers were expected to add 170k jobs in December, they actually added 216k, which was up from the 199k added in November, and the unemployment rate remained at a mere 3.7%. The Labor Department also reported that wages rose 4.1% from a year earlier, ahead of both the consensus of 3.9% and inflation. For the full year, healthcare, social assistance, and restaurant industries were big job creators, and construction employment hit a fresh record. Furthermore, the Federal Reserve Bank of New York stated this week that Americans believe that consumer prices will only rise by 3% this year, which is the lowest polled number since January 2021. Consumers’ 3-year inflation expectation also fell to 2.6%. With a strong and stable labor market and inflation expectations moving increasingly toward the Fed’s 2% target, a wait-and-see approach instead of aggressive cuts appears a more likely path, but then again, at this time last year, a recession appeared to be right around the corner. It’s probably best not to assume knowledge of the future and, instead, plan for a range of possible outcomes.

What happened in the markets during the quarter?


With earnings season just about to kick off, FactSet is reporting a 4Q estimate of 1.3% year-over-year earnings growth for the S&P 500, which would be the second straight quarter of positive growth but would come in well below where that estimate sat at the end of September, thanks to healthy downward revisions. But those revisions did little to dent enthusiasm for stocks during the quarter. REITs were the big winners, advancing by over 16%, with small caps nipping at their heels; the S&P 600 gained over 15%, slightly outpacing the lower-quality Russell 2000, which returned about 14%. As mentioned earlier, large caps also performed brilliantly, delivering a return of 11.7%, sufficient to crown the S&P 500 as the winner of the annual asset class competition.

Overseas, the trend was the same, small caps outperformed large caps, and both generated healthy returns of 11.1% and 10.4%, respectively. A decline in the U.S. dollar was responsible for about half of the return produced by international developed stocks for U.S.-based investors.

At the sector level, only energy stocks were down for the quarter, as oil prices fell by over 19%; energy stocks within the S&P 1500 declined by almost 7%. But over half of the S&P’s constituent sectors generated double-digit returns, with tech (+16.9%), financials (+14.3%), and consumer discretionary (+13.1%) coming out on top.


Myriad economic data releases, endless parsing of Fed-speak, and exhausting speculation about the direction of interest rates over the course of the year left the yield on the 10-year Treasury exactly where it started, at 3.88%. But it did touch 5% during the month of October and fell throughout the remainder of the quarter, rewarding fixed-income investors of all types. A pure play on duration, long-term Treasuries rallied the hardest, gaining 12.3%. But high single digit returns were had during the quarter from holding investment grade corporates (+8.2%), munis (+7.9%), and high yield bonds (+7.1%), as the overall bond market gained 6.6%. Leveraged loans, which aren’t interest rate sensitive, brought up the rear, earning “only” 3.2% for the quarter, to end the year with a gain of 13.2%, narrowly losing out to high yield bonds as the best performing fixed income asset class. And high yield spreads ended at about their lowest point for the year at 332 basis points, down from 522 back in March.


Commodities fell by 4.6% for the quarter and retreated by almost 8% for the year, with the energy complex down by 18.2% and 21.6% for the quarter and year, respectively. Brent and WTI crude futures both fell hard in each of the final three months of the year. Both agricultural and industrial metals contracts were essentially flat for the quarter, while precious metals were able to advance by 10.4%.

How are Frontier strategies positioned?


Due to the complexities of attempting to generalize about allocation changes across our Core, Specialty, Tax-Managed, Multi-Asset Income, and Faith-Based Strategies and the additional difficulties of properly conveying how those asset allocation changes flow through to trade level activity, we are instead directing clients to our monthly trade summaries, which describe in detail what trade activity occurred by strategy, and why.

Focusing on our Core Strategies relative to their long-term asset allocations, which serve as policy portfolios guiding our dynamic allocation decisions, we favor U.S. and international small caps, emerging market equities, managed futures, floating rate loans, and cash/short-term bonds. We are generally underweight U.S. and international large cap stocks, REITs, commodities, and both high-yield and high-quality bonds at the asset allocation level, but differences between the asset allocations and actual exposure at the fund level can and will occur. At the beginning of January, our asset allocation models modestly increased cash and short-duration fixed income at the expense of minor reductions across a number of asset classes, given the fourth quarter everything rally.

Return expectations for emerging market equities and international small caps continue to remain near the tops of their respective 20-year ranges. Expectations for TIPS, managed futures, floating rate loans, and T-bills are likewise high relative to history. U.S. large caps remain near their 20-year lows, as do REITs.


Given our risk-first orientation, expressed by specific downside targets, while all our strategies produced solid returns for the month, quarter, and year, as could be expected, we did not keep up with more aggressively positioned strategies. Our preference for global small caps helped, as did our underweight to commodities, and our remaining exposure to long-term Treasuries. But our underweight to REITs, overweight to emerging markets, a lower duration focus in many strategies, and managed futures exposure all hurt relative performance.

[1] The group is made up of mega-cap stocks Apple (AAPL), Alphabet (GOOGL), Microsoft (MSFT), (AMZN), Meta Platforms (META), Tesla (TSLA) and Nvidia (NVDA)

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U.S. Large Cap Equity S&P 500 Represents US large company stocks.
U.S. Small Cap Equity Russell 2000 A small-cap U.S. stock market index that makes up the smallest 2,000 stocks in the Russell 3000 Index.
Broad U.S. Equity S&P 1500 A stock market index of US stocks made by Standard & Poor’s. It includes all stocks in the S&P 500, S&P 400, and S&P 600.
U.S. Small Cap Equity S&P 600 A stock market index made up of 101 equity securities issued by 100 of the largest non-financial companies listed on the Nasdaq stock exchange.
International Equity MSCI EAFE An equity index which captures large and mid cap representation across 21 Developed Markets countries around the world, excluding the US and Canada.
Emerging Market Equity MSCI Emerging Markets Captures large and mid cap representation across 24 Emerging Markets (EM) countries.
Investment Grade Corporates Morningstar US Corporate Bond Measures the performance of fixed-rate, investment-grade USD-denominated corporate bonds with maturities greater than one year.
High Yield Bonds Morningstar U.S. High Yield Bonds Measures the performance of USD-denominated high-yield corporate debt. It is market-capitalization weighted.
TIPS Morningstar US TIPS Represents inflation-protected securities issued by the U.S. Treasury.
Leveraged Loans S&P / LSTA U.S. Leveraged Loan 100 Designed to reflect the performance of the largest facilities in the leveraged loan market.
Municipal Bonds Morningstar US Municipal Bond Measures the performance of fixed-rate, investment-grade USD denominated tax-exempt debt issued by U.S. state, U.S territory, and local government entities with maturities greater than one year.
Long-Term Treasuries Morningstar US 10+ Yr Treasury Bond Measures the performance of fixed-rate, investment-grade USD-denominated Treasury bonds with maturities greater than ten years.
REITS FTSE NAREIT Equity REIT A free-float adjusted, market capitalization-weighted index of U.S. equity REITs.
Commodities Bloomberg Commodity Broadly diversified index that allows investors to track commodity futures through a single, simple measure. The DJ-UBSCISM is composed of futures contracts on physical commodities.


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