Three important insights from 2023
A focus on bond yields, the Magnificent 7, and the Fed pivot.
January 2024, From the Field
We have learned a lot during 2023, including these three important insights that investors should keep in mind as we enter 2024.
After an extended period of extremely low yields in bonds, yields have finally rebounded. From 2013 to 2021, the average yield to worst for the Bloomberg Global High Yield Bond Index was a modest 6.04% but stood at 8.36% as of December 15. Even more striking, the average yield to worst for the Bloomberg Global Aggregate Index was 1.57% from 2013 to 2021 but was more than twice that level on December 15 at 3.60%.
Now that the Fed has signaled intentions to cut rates in 2024, we can expect to see yields drift lower. But we should not expect a return to the anemic levels of the 2010s, as long as inflation remains a threat. This means that current yield can once again be a useful feature in bond portfolios as we move into 2024.
In 2023, we witnessed one of the most top-heavy equity markets ever. The “Magnificent 7” posted massive returns—gaining over 70% through December 15 on a market cap-weighted basis. Meanwhile, the other 493 stocks in the S&P 500 returned 13.6% on a market cap-weighted basis—a lower return than that of MSCI EAFE Index, which gained 15.7%. This massive gap drove home a lesson that we believe investors need to be keenly aware of: The Magnificent 7 should be viewed as a separate asset class.
It is tempting to look at the valuations of U.S. stocks and conclude that they are too expensive and should therefore be avoided in favor of stocks in other regions of the world. But the reality is that U.S. stocks are not broadly expensive. Rather, the aggregate valuation of U.S. stocks is distorted by the high valuations of these seven “mega-cap” companies that make up nearly 30% of the index.
It is also tempting to assume that valuations of the Magnificent 7 are unreasonably high. Whether these elevated valuations are warranted is a difficult question to answer, but one simple way to provide a sanity check is to compare a P/E ratio to return on equity—a measure of how profitable and efficient a company has been over the past year. For the Magnificent 7, their high valuations were accompanied by similarly high returns on equity as of December 18.
The bottom line is that the elevated valuations of the Magnificent 7 collectively, and U.S. stocks in aggregate, are not unreasonable when taken in context. The real question is whether or not the level of profitability and efficiency that these seven companies have exhibited can be sustained moving forward.
One of the most notable developments of 2023 came at the end of the year when the Federal Open Market Committee delivered a surprisingly dovish signal at its December meeting. Fed Chairman Powell has spent most of 2023 telling us that it would prioritize fighting inflation over supporting the economy in the foreseeable future. But in December, the Fed changed its tune. First we got a dovish set of forecasts in the Summary of Economic Projections. Then, in the post-meeting press conference, Powell told us that they would be giving equal attention to their two mandates—fighting inflation and supporting the economy—going forward.
This is a big deal. We spent 2023 fearing that the impacts of tight monetary policy would drag the economy into recession. Happily, that did not happen, and a more dovish Fed means the likelihood of recession in 2024 has fallen considerably.
We will be closely monitoring all of these issues as we move into 2024 and will update you accordingly as they play out.
Key Insights
- Bond yields have rebounded and are unlikely to return to the anemic levels of the 2010s, despite the Fed’s dovish pivot.
- Given the significant outperformance and high returns on equity by the Magnificent 7 companies collectively, we believe they should be viewed as a separate asset class.
Written by
Tim Murray, CFA
Capital Markets Strategist, Multi-Asset Division
Another year has gone by, and looking back, we learned a lot in 2023. Here are three key insights investors should keep in mind as we enter 2024.
Yield is back.
Bond yields have finally rebounded. During the period 2013–2021, the average yield to worst for the Bloomberg Global High Yield Bond Index and the Bloomberg Global Aggregate Index was a modest 6.04% and 1.57%, respectively. As of December 15, 2023, this measure was 8.36% for the global high yield index and 3.60% for the global aggregate index.
Although they may drift lower, given the Fed’s recent dovish signal, bond yields are unlikely to return to the anemic levels of the 2010s as long as inflation remains a threat. Current yield can, therefore, once again be a useful feature in bond portfolios as we move into 2024.
The Magnificent 7 should be viewed as a separate asset class.
We witnessed the most top-heavy equity markets ever in 2023. The Magnificent 7—a group of stocks that includes Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, NVIDIA, and Tesla—posted massive returns and significantly outpaced their peers in the S&P 500 Index and other global stocks (Figure 1). Given this huge gap in performance, we believe the Magnificent 7 should be viewed as a separate asset class.
Magnificent 7 significantly outperformed other stocks in 2023
(Fig. 1) Comparing year-to-date total returns of mega-cap stocks versus other S&P 500 and global stocks
December 31, 2022, through December 15, 2023.
Past performance is not a reliable indicator of future performance. These statistics are not a projection of future results or company performance.Actual results may vary significantly.
Sources: T. Rowe Price analysis using data from FactSet Research Systems Inc. All rights reserved. MSCI and S&P indices. See Additional Disclosures.
* The Magnificent 7 stocks are Apple, Alphabet, Amazon.com, Meta Platforms, Microsoft, NVIDIA, and Tesla. The specific securities identified anddescribed are for informational purposes only and do not represent recommendations. Not representative of an actual investment. There is no assurancethat an investment in any security was or will be profitable.
The high valuations of these seven mega‑cap companies collectively, which make up nearly 30% of the S&P 500 Index, has distorted overall U.S. stock valuations. While these high valuations have been accompanied by similarly high returns on equity as of December 18, the real question is whether the Magnificent 7 will be able to sustain the level of profitability and efficiency that they have so far exhibited.
The Fed has pivoted.
The surprisingly dovish signal from the Federal Open Market Committee—a softer rate hike narrative and lower economic projections—at the end of its December meeting was one of the most notable events of the year. Investors spent 2023 fearing that the impacts of tighter monetary policy, amid the Federal Reserve’s (Fed) focus on fighting inflation, would drag the U.S. economy into recession. Fed Chair Jerome Powell’s recent announcement that the Fed would be giving equal attention to its two mandates—fighting inflation and supporting the economy—going forward means that the likelihood of recession in 2024 has fallen considerably.
We will be closely monitoring all of these themes as we move into 2024 and will update you accordingly as they play out.
A dovish Fed signal lowers the likelihood of recession
(Fig. 2) Fed funds effective rate and futures market pricing
December 31, 2020, through December 15, 2023.
Past results are not a reliable indicator of future results. Actual outcomes may differ materially from forward estimates.
Sources: Bloomberg Finance L.P.
How attractive are U.S. small-cap stocks?
Cheap valuations and an improving outlook favor small-caps, but high rates are problematic.
1 Yield to worst is a measure of the lowest possible yield that can be received on a bond with an early retirement provision.
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