Portfolio Strategy Review 2023

by | Jan 14, 2024 | Portfolio Strategy


Risk on. Risk off. 2023 was a risk on year. 2022 not so. Short-term risk of volatility is common in financial markets and what we guard against as we get closer to retirement.

In early 2023, consensus views were that inflation, high interest rates, and recession fears did not bode well for stocks. Interest rates were widely forecast to fall as the economy weakened into recession. Recessions are not good for most stocks, so large cap value oriented defensive sectors were favored. Yet it was large technology growth companies, led by the Magnificent 7, that fueled most of the year’s increase. Value underperformed growth by a wide margin for all of 2023.

Rates finally fell in October, but it was not due to a recession. Markets interpreted (hoped) that Federal Reserve comments signaled numerous rate cuts were on the way. Signal or noise?

In any case, lower rates in a good economy tend to make financial assets attractive and almost all markets surged higher on speculation that interest rate cuts were on the way. Market strategists believe this broadening of growth beyond the Magnificent 7 is a healthy market indicator.

The path for interest rates is still a question. The jury is out on how much and how soon interest rate cuts may occur. The Fed does not want to act too early and reignite inflation. Rates may not decline as markets had hoped.

Is the AI Boom Already Priced In?

As we enter 2024, some analysts believe that AI will bring a technology led investment boom like we saw in the 1990’s; and that AI applications will drive economic growth and productivity. In contrast, more measured views note that valuations on the S&P 500 are at a high level that historically has meant lower future returns.

Valuation is Art, Science, and Hard to Foretell

The Price-Earnings ratio (PE) is a common shorthand metric used to gauge the valuation of stocks. It is the price we pay for corporate earnings. All things being equal, a high PE could mean you are paying too much, and your future returns may be lower; therefore, a low PE would mean you are getting a bargain that may generate better future returns. If you followed this simple math, Int’l Small Cap and Emerging Markets offer the lowest PE. Small caps are also cheap. Yet large growth performance has dominated for the past 10 years, even as large growth PE ratios have remained high.

Alas, all things are not equal. Valuation is more than a simple math equation. Valuation incorporates profit margins, cost of capital, business risk, return on capital, growth, investor expectations, interest rates, and most importantly, business sustainability into the future. In a complex, hyper competitive world, sustainability is very difficult to maintain with even the most skilled business executives. These complexities are why over 90% of portfolio managers fail to beat their benchmarks. And we have yet to discuss the domestic and geopolitical issues which further add to complexity.

History shows that growth and value, large cap and small cap, US and international don’t always move in the same direction at the same time. There are periods when they diverge. However, through economic cycles and over time they have tended to generate similar returns.

These complexities are why diversification and the right asset mix help increase the odds for a successful retirement.

Economic and Political Risks

Q: How can you tell if a politician is lying?
A: Their lips are moving.

In an election year, we are certain to hear hyperbolic policy declarations about the economy and fixes for the country’s deficit problem. Trump’s unfunded tax cuts started the fiscal deficit blowup. Biden added to it. Neither demonstrated fiscal discipline during their tenures. The pandemic complicated matters.

The concern with fiscal deficits is that they will force interest rates higher. Never mind what the Federal Reserve does. If institutional investors (aka the “bond vigilantes”) boycott US debt securities until they get higher rates to compensate for higher risk of repayment, the cost of money will increase and that would slow the economy and hurt financial markets and real estate.

Objective analysts, who keep their political views aside, prescribe harsh medicine: Both higher taxes and spending cuts. In an election year you won’t hear much of that on the campaign trail. And with the extremist elements in Congress, solutions will be hard to achieve.

The good news is that relative to other major countries, the US still holds a number of economic and demographic advantages. As long as capitalism is alive and well, there is ample reason to believe that markets will do what they have always done.

Jerry Matecun – Founder, President
Expert guidance to plan your future, preserve your lifestyle, and retire with confidence. For a confidential consult, contact me at jerry@compoundvalue.com.

PLEASE NOTE: You can’t invest directly in an index. Past performance does not guarantee future performance. All investments are subject to risk, including possible loss of the money you invest. Diversification does not guarantee profit or protect against a loss. Nothing herein or elsewhere on this site constitutes investment, legal, or tax advice. For details please see Disclosure.

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