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.