While the stock market seems to be off to a strong start in 2023, leadership has come from a select few. See which are winning and losing.
It’s been an interesting year so far regarding market performance. Despite sticky inflation, a regional banking crisis, debt ceiling squabbles, and signs of a slowing economy, equity markets have delivered strong returns in the first four months of the year. U.S. stocks returned 8.32%, compared with 11.8% for non-U.S. developed stocks. Emerging markets came in at 2.86% for the same period.1
The re-emergence of positive equity market returns has investors opening their eyes again, to sift their portfolios and ask questions about winners and losers. By and large, U.S. stocks this year have underperformed their non-U.S. developed counterparts and have outperformed emerging markets (Exhibit A). Except for emerging markets, growth has outperformed value, and large cap has outperformed small cap, through April 30.
Exhibit A: Style returns for U.S., non-U.S., and emerging markets, through April 30, 2023.
Source: Avantis Investors
Strong stock market performance so far this year raises an interesting question: With all the negative news, what’s driving U.S. equities higher? Markets certainly aren’t cheap, especially given the steep rate hikes by the Federal Reserve. A few factors can help you make sense of the positive returns:
Exhibit B: Markets tend to do well in the years following a steep loss.
Source: Dimensional Fund Advisors
Here are a few more thoughts about the 10 darlings that have pushed the S&P 500 higher this year:
Given our new world where interest rates are both (1) positive and (2) quite high, it might help to convert these forward P/E ratios to their earnings yields to provide some context for “what stocks are paying.” The earnings yield is just the inverse of the P/E ratio. Simply divide the P/E ratio into one. A forward P/E ratio of 37 equals 2.7% (1/37) average earnings yield for the darlings. For context, six-month Treasuries currently yield 5.1%.
Mercer Advisors’ Global Multifactor Equity Portfolio and U.S. Large Cap Multifactor Portfolio both own all ten darlings. In fact, the U.S. Large Cap Multifactor sleeve owns all of these companies in weights not that different from the S&P 500 (Exhibit C). However, any decision to diversify beyond the index—for example, to include things like small caps, non-U.S. stocks, or fixed income—means owning the darlings in weights lower than the S&P 500. Therefore, it’s not surprising when portfolios deliver returns different from those of an index of only U.S. large cap stocks.
Exhibit C: The darlings.
|Mercer Advisors Portfolio Weights|
|The Darlings of 2023||Index Weight||US Large Cap Mtfcr Port. Weights||Global Mtfcr Port. Weights||2022 Returns||2023 Returns||Fwd PE|
|Meta Platforms Inc. Class A||1.19||1.15||0.69||-64.22||99.70||20.61|
|Visa Inc. Class A||1.08||1.05||0.63||-4.13||12.24||27.04|
|Advanced Micro Devices, Inc.||0.40||0.38||0.23||-54.99||37.98||32.81|
Source: Factset, Inc.
Past returns are material only in that they tell us something about expected returns going forward. Yet there’s no evidence that we should expect the darlings, given their high valuations, to deliver outsized returns in the future, relative to their value-stock counterparts. If prices matter and valuations are any guide, we should expect them to underperform over time.
Since 1926, value stocks have outperformed growth stocks 59% of the time, out of 1,135 overlapping, rolling one-year periods. And those odds increase with time, rising ultimately to 80% of rolling 10-year periods. Those are great odds in our business—probably the best we can expect.
Exhibit D: Value and growth stock long-term performance.
Source. Dimensional Fund Advisors
There’s certainly a chance that the darlings—and their growth stock amigos—might outperform value stocks despite their high valuations. It wouldn’t be unprecedented. Indeed, growth has beat value 41% of the time over rolling one-year periods since 1926. This has also been the case recently, with growth stocks outperforming value stocks in the past decade, which has happened about 20% of the time since 1926. If they do so in the future, the good news is that we own them. If they don’t, the good news is that we’re underweight.
As fiduciaries, Mercer Advisors has a legal, moral, and ethical obligation to diversify client portfolios. By definition, diversification means underperforming the hottest and best-performing asset classes at any given time. That’s not an opinion; it’s a matter of simple arithmetic. It also means protecting our clients’ futures from the wealth destruction that all too often comes from concentrated portfolios, market timing, performance chasing, and expensive investment products.
Diversified portfolios may not always offer exciting outperformance; in fact, they rarely do. But what they can offer is the wisdom, reassurance, and boredom that characterizes successful, long-term investing.
1 Ycharts, through 4/30/2023.
2 Ycharts, through 4/30/2023.
3 Ycharts, through 4/30/2023.
4 FactSet, Inc.
5 JPMorgan Guide to the Markets, April 30, 2023.
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