2023: Another Year When Ignoring the Oracles Paid Off

The 4 Key Events of 2023 That Shaped Capital Markets in Charts

Throughout the year, the Federal Reserve—and other central banks worldwide—increased interest rates four times as part of an aggressive strategy initiated in 2022 to curb persistent inflation and prevent the economy from overheating. 

The impact of higher interest rates was felt across various financial assets like stocks and bonds but also raised concerns about the solvency of a few financial institutions that were careless with their assets and liabilities risk management.

On March 10, 2023, Silicon Valley Bank, a key lender to tech firms, experienced a sudden bank run, was forced to sell assets at a deep discount, and collapsed. Shortly afterward, First Republic, Signature, Silvergate, and the Swiss banking giant Credit Suisse—albeit for different reasons, faced a similar fate. Although the crisis did not linger, it was not trivial in its scope:

In 2023, the dominant stock market trend was the excitement surrounding artificial intelligence (A.I.). Following the successful introduction of ChatGPT a year earlier, investors were eager to participate in the A.I. boom, and Nvidia, a manufacturer of processors that runs the underlying models, saw its fortunes increase dramatically: 

After discarding them in 2022, investors also favored the "Magnificent Seven," the largest tech companies in the market, including Nvidia, Tesla, Meta Platforms, Apple, Amazon.com, Microsoft, and Alphabet. Despite a stumble in August due to soaring bond yields, the group rebounded in November. It could have been smoother sailing for tech workers: Microsoft and Meta each laid off 10,000 employees, while Google laid off 12,000.

Towards the end of the year, financial markets experienced a substantial recovery, primarily driven by renewed confidence in the Federal Reserve's ability to navigate a soft landing for the U.S. economy. The catalyst behind the reversal of fortune was the expected shift in Fed policy from interest rate increases to cuts for 2024. While markets wrongly priced in such a pivot several times over the past year and a half, inflation pressures had abated enough by year-end to make it a more likely scenario.

All in all, 2023 marked a stark contrast to the challenges of 2022, with the bond market showing a 5.5% increase for the year, compared to 13% losses in 2022. The S&P 500—a proxy for the biggest companies in the U.S. stock market—also saw a significant rise, up 26% for 2023, compared to the 18% losses in 2022. Yet, as the chart below illustrates, despite this year-to-year volatility, U.S. stock prices have been more or less flat since the November 2021 peak:

Broadening our review to other asset classes’ benchmarks within our balanced portfolios, all but Commodities were up in 2023 (and in the 4th quarter). Small Cap and International stocks lagged US Large Cap but delivered positive returns in the mid to high teens. Over the last three years, only Emerging Market stocks and US Bonds delivered a negative performance. 

In 2023, by and large, our balanced portfolios had positive returns in the low to mid-teens. Within the Equity allocation, our US Large Cap holdings typically lagged the index (due to our relative underweight to the “Magnificent Seven”), but our combined investment selections outperformed their respective benchmark in all other stock segments (US Small Cap, International, Emerging Markets, Real Estate and Natural Resources). Our collective holdings' returns also beat their benchmark within the ‘Fixed Income’ and ‘Other Assets’ allocations (Note that your portfolio is customized to fit your goals and financial circumstances, and that its performance might differ. Please refer to your 4th quarter report).

During the quarter, the only change to our fund holdings was to sell our remaining investments in the arbitrage investment strategy. We reallocated the proceeds among our core bond funds for most clients. As we mentioned in early 2023 when we started reducing this allocation, arbitrage funds served their purpose over the past few years by outperforming cash and bonds. But with fixed income yields now over 4%, the prospective risk-adjusted return from high-quality bonds of short to intermediate maturities appeared more attractive. 

Large Cap Value (LCV) Review

(Not all clients of Bristlecone are invested in our Large Cap Value Equity portfolio strategy, depending on the overall portfolio size and the client's objectives and constraints.)

The LCV portfolio's performance trailed the Russell 1000 Value by a small margin but underperformed the S&P 500 in 2023 more significantly, continuing the pattern of the past few years. After underperforming in 2022, growth stocks returned strongly during 2023 and dramatically outperformed value stocks. 

Meta Platforms, up 194% in 2023, was our best performer (and second-best in the S&P 500) due to investor excitement around A.I. in advertising and increased profit margins from cost-cutting. Intel Corp (up 95%) and Cemex (up 91%) were the following best performers for the year. Intel's efforts to regain parity with Taiwan Semiconductor in manufacturing appear to gain traction, and investors took notice. At the same time, thanks to multi-year nearshoring and infrastructure spending trends in the U.S., Cemex found success in raising cement prices, offsetting volume weakness in its other key markets.    

Our worst investments were Hanesbrands (down 30%), Valmont (down 29%), and Bayer (down 26%). Hanesbrands has suffered from high inventory levels among its retailers (e.g., Target and Walmart), high input costs for cotton, and inefficient production. We believe the worst is behind it, and results should normalize to higher earnings and more robust cash flows this year. Valmont's agricultural markets tend to be cyclical and sensitive to higher interest rates, but we do not see any reason to revise our long-term positive thesis. Finally, Bayer was hit by more adverse jury decisions (along with some wins, too) in the litigation against Monsanto's Round-Up. We continue to believe that the stock price does not reflect—even accounting for a substantial litigation liability—the value of its three operating segments: pharmaceuticals, crop science, and consumer health. A recent CEO change may be a positive catalyst toward reorganizing the business, capping the litigation risk, and closing the gap between the current stock price and the underlying value.

 During the quarter, we increased our investment in Hagerty, a specialty insurance company that we discussed in our 3rd quarter commentary. There were no other new purchases or sales, but we harvested tax losses for some of our taxable accounts when appropriate. 

“The Dogs Bark but The Caravan Goes On”

As our headline indicates, 2023 was another year when ignoring forecasts paid off: back in December 2022, investors were warned to brace for more pain in 2023. At the time, numerous analysts had openly predicted a significant recession. Barclays Capital predicted that 2023 would become "one of the worst for the world economy in four decades." Fidelity International stated that a hard landing looked "unavoidable." J.P. Morgan's team of analysts expected the S&P 500 to "fall back toward the lows seen in 2022 before a pivot by the Fed fuels a second-half rebound."

Despite all the warnings to the contrary, 2023 turned out to be great for investors. A feared recession failed to materialize, even as the Federal Reserve hiked interest rates to their highest level in over a decade and geopolitical tensions threatened to destabilize the global economy. Stocks and bonds soared. But Wall Street strategists will make predictions anyway, despite an unambiguously poor track record.

Rather than pay attention to these useless oracles, we stick to a disciplined investment strategy that has delivered predictable long-term outcomes through different types of—unpredictable—market environments: diversify across asset classes and ride out the cycles. The caravan goes on.

Our approach is anchored by three lessons that can be drawn from looking at the table below (not updated yet for 2023):
 

1. The best index keeps changing: even if some asset classes have better long-term average returns, they do not win every year. 
2. It is impossible to predict next year's winner.
3. Some asset classes are clearly more volatile: glancing at stock indices or commodities will show that these categories' returns span a wide range.

Keeping in mind that asset class returns converge to their long-term average over time, diversifying one's portfolio across them is, therefore, the most sensible strategy; otherwise, due to bad timing, one could end up not reaching one's financial goals. At the same time, a properly diversified portfolio will never match or exceed the best asset class in any given period. It is always doomed to trail the best category. By increasing the odds of reaching our destination, we give up any chance of winning the intermediate sprints.

2024 is an election year when more than half of the world population will vote to elect new leaders from the U.S. to Mexico, India, Russia, and Europe… so expect drama and volatility!

One of Bristlecone Value Partners’ principles is to communicate frequently, openly and honestly. We believe that our clients benefit from understanding our investment philosophy and process. Our views and opinions regarding investment prospects are "forward looking statements," which may or may not be accurate over the long term. While we believe we have a reasonable basis for our appraisals, and we have confidence in our opinions, actual results may differ materially from those we anticipate. Information provided in this blog should not be considered as a recommendation to purchase or sell any particular security. You can identify forward looking statements by words like "believe," "expect," "anticipate," or similar expressions when discussing particular portfolio holdings. We cannot assure future results and achievements. You should not place undue reliance on forward looking statements, which speak only as of the date of the blog entry. We disclaim any obligation to update or alter any forward-looking statements, whether as a result of new information, future events, or otherwise. Our comments are intended to reflect trading activity in a mature, unrestricted portfolio and might not be representative of actual activity in all portfolios. Portfolio holdings are subject to change without notice. Current and future performance may be lower or higher than the performance quoted in this blog.References to indexes and benchmarks are hypothetical illustrations of aggregate returns and do not reflect the performance of any actual investment. Investors cannot invest in an index and returns do not reflect the deduction of advisory fees or other trading expenses. There can be no assurance that current investments will be profitable. Actual realized returns will depend on, among other factors, the value of assets and market conditions at the time of disposition, any related transaction costs, and the timing of the purchase.Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there can be no assurance that a portfolio will match or outperform any particular index or benchmark. Past Performance is not indicative of future results. All investment strategies have the potential for profit or loss; changes in investment strategies, contributions or withdrawals may materially alter the performance and results of a portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client's investment portfolio.This content is developed from sources believed to be providing accurate information, and it may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.