What Caused 2023’s ‘Everything’ Rally?

Heading
into
the
year,
investors
expected
more
difficulty
for
the
stock
and
bond
markets
after
the
2022
bloodletting.
The
stock
market’s
outlook
certainly
seemed
dicey;
the
Federal
Reserve
was
continuing
its
unprecedented
series
of
interest
rate
increases,
and
most
investors
felt
“the
most-advertised
recession
in
history”
was
just
months
away.
Even
those
in
the
more
optimistic
camp
felt
we
would
see
mid-single-digit
gains
at
best
by
year-end.

Instead,
2023
turned
into
one
of
the
biggest
years
for
stock
market
performance
in
the
past
decade,
with
the Morningstar
US
Market
Index up
26.4%.
It
was
especially
good
for
the
kinds
of
mega-cap
technology
stocks
and
other
growth
companies
that
suffered
the
biggest
losses
in
the
2022
bear
market.

The
poster
child
for
the
2023
rally
is
semiconductor
chip
designer
Nvidia
(NVDA),
whose
stock
rallied
a
massive
239%
during
the
year,
as
the
emergence
of
artificial
intelligence
(AI)
technologies
looked
to
reshape
the
tech-stock
landscape.
In
2022,
Nvidia’s
value
had
been
cut
in
half.

Bonds
also
managed
a
noteworthy
comeback,
even
if
the
gains
were
small
for
most
investors.

The
catalyst
behind
the
reversal
of
fortune
was
the
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,
by
year-end,
inflation
pressures
had
turned
strongly
enough
toward
disinflation
to
make
it
a
reality.

Here
are
some
of
the
highlights
of
2023’s
markets.

Key
Stats:
2023
Stock
and
Bond
Market
Performance

• US
  Stocks
  rose
  26.4%
  (including
  dividends),
  the
  biggest
  rally
  in
  the
  US
  Market
  Index
  since
  2019;
• Stocks
  were
  up
  12.1%
  in
  the
  fourth
  quarter,
  the
  index’s
  best
  quarterly
  performance
  since
  late
  2020;
• Since
  hitting
  their
  bear-market
  low
  in
  October
  2022,
  stocks
  have
  rallied
  36%;
• Technology
  stocks
  posted
  a
  huge
  year,
  surging
  59.1%
  for
  their
  best
  performance
  since
  2009.
  Along
  with
  Nvidia,
  chip
  manufacturer
  Advanced
  Micro
  Devices
  (AMD) jumped
  128%;
• Communications
  Services
  ranked
  second
  among
  stock
  sectors,
  gaining
  54.5%,
  led
  by
  rallies
  in
  Alphabet
  (GOOGL),
  Meta
  Platforms
  (META),
  and
  Netflix
  (NFLX);
• The
  so-called
  “Magnificent
  Seven”
  stocks
  contributed
  nearly
  half
  of
  the
  stock
  market’s
  overall
  gain;
• Large-growth
  stocks
  gained
  47.3%,
  blowing
  away
  large-value
  stocks
  by
  36
  percentage
  points –
  the
  second-biggest
  advantage
  for
  growth
  in
  25
  years;
• Utilities
  stocks
  stumbled,
  losing
  7% –
  their
  worst
  year
  since
  2008—dragged
  down
  by
  higher
  interest
  rates;
• Dividend
  stocks
  lagged
  the
  broader
  market.
  The Morningstar
  US
  Dividend
  Composite
  Index rose
  11%;
• Volatility
  remained
  very
  high
  in
  bonds,
  with
  some
  parts
  of
  the
  bond
  market
  staging
  a
  round
  trip
  over
  the
  year.
  The
  yield
  on
  the
  U.S.
  Treasury
  10-year
  note
  started
  and
  finished
  2023
  near
  3.8%,
  but
  during
  the
  year
  rose
  to
  a
  17-year
  high
  near
  5%;
• Credit-sensitive
  corners
  of
  the
  bond
  market
  performed
  strongly
  as
  the
  economy
  avoided
  recession.
  High-yield
  bonds
  gained
  13.5%,
  making
  for
  their
  best
  year
  since
  2019.

2023
Stock
Market
Performance

Heading
into
2023,
there
was
budding
optimism
the
worst
was
over
for
the
stock
market
after
it
hit
what
appeared
to
be
bear-market
lows
in
October
2022.
However,
with
inflation
still
at
lofty
levels
and
the
Fed
still
actively
raising
interest
rates,
caution
continued
to
dominate.
For
stock
investors
in
particular,
there
were
widespread
concerns
that
the
economy
would
slide
into
a
recession
in
2023.

Those
fears
took
on
new
life
in
March
following
the
collapses
of
Silicon
Valley
Bank,
Signature
Bank,
and
First
Republic
Bank.
These
failures,
which
stemmed
from
huge
losses
the
banks
suffered
in
holdings
of
government
bonds,
sparked
fears
of
a
full-blown
regional
banking
crisis
and
the
potential
for
a
credit
crunch
that
could
tip
the
economy
into
a
decline.

But
with
the
Fed
stepping
in
quickly
to
ease
the
pressure
on
regional
banks
holding
troubled
bond
portfolios,
confidence
quickly
returned
to
the
stock
market.

At
the
same
time,
enthusiasm
bubbled
over
around
technology
stocks
in
the
wake
of
Nvidia’s
blowout
first-quarter
earnings
report
in
May.
The
key
driver
was
the
booming
business
of
supplying
chips
for
AI
development.

Bolstering
the
outlook
for
equities
was
surprisingly
strong
job
growth.
As
the
year
wore
on,
concerns
about
a
recession
dwindled.
Meanwhile,
corporate
earnings,
which
started
2023
in
a
slump,
also
showed
signs
of
health.

However,
many
investors
remained
wary
of
the
market’s
rally,
in
part
because
it
was
so
heavily
concentrated
in
just
a
handful
of
names,
specifically
the
so-called
“Magnificent
Seven.”
As
of
the
end
of
May,
nearly
all
the
market’s
gains
came
from
the
10
largest
stocks.

Still,
in
June
stocks
crossed
into
new
bull
market
territory,
gaining
20%
from
the
bear
market
low.
By
the
end
of
July,
the
US
Market
Index
was
up
nearly
28%
from
October
2022
and
20%
since
the
start
of
2023.

Stocks
then
ran
into
an
unexpected
air
pocket
in
the
form
of
a
sudden
sharp
sell-off
in
the
bond
market
which
saw
the
yield
on
the
US
Treasury
10-year
note
jump
to
a
17-year
high
near
5%.
Between
July
31
and
Oct.
27,
the
US
Market
Index
fell
just
over
10%,
entering
formal
correction
territory.

But
once
more,
sentiment
reversed,
this
time
as
evidence
accumulated
that
not
only
was
inflation
continuing
to
trend
lower,
but
that
job
growth
was
also
moderating.
Expectations
began
to
build
that
the
Fed
had
raised
interest
rates
for
the
last
time
at
its
July
meeting
and
that
it
would
soon
shift
to
rate
cuts.
By
the
time
the
Fed
signaled
its
pivot
toward
cutting
rates
in
2024,
stocks
were
well
on
their
way
to
a
17%
rally
from
October
lows,
and
the
market
finished
2023
at
its
highs
for
the
year.

2023
Stock
Sector
Performance

When
it
came
to
the
various
stock
sectors,
the
primary
theme
of
2023
was
“a
reversal
of
fortune.”

Sectors
that
had
been
the
most
buoyant
during
the
bear
market
lagged
significantly
in
2023,
while
those
that
took
the
biggest
beating
in
2022
roared
ahead
with
big
gains.

That
was
especially
the
case
for
technology
stocks
and
the
communications
services
sector,
which
saw
big
rallies
north
of
50%
in
2023.
Contrast
that
with
2022,
when
the Morningstar
US
Communications
Services
Index was
the
worst-performing
sector
benchmark,
losing
40.9%.
The Morningstar
US
Technology
Index had
placed
third
with
a
31.6%
drop,
behind
the
35.5%
loss
in
the Morningstar
US
Consumer
Cyclical
Index.

Powering
the
gains
in
the
tech
and
communications
services
sectors
(along
with
the
jump
in
the
consumer
cyclical
sector)
were
the
Magnificent
Seven.
The
group
comprises
Nvidia,
Tesla
(TSLA),
Meta,
Apple
(AAPL),
Amazon.com
(AMZN),
Microsoft
(MSFT),
and
Alphabet.

Even
Apple,
the
worst
performer
of
the
group,
posted
gains
more
than
20
percentage
points
ahead
of
the
broader
market.
However,
thanks
to
the
big
rally, technology
stocks
are
now
the
most
expensive sector,
based
on
Morningstar
analysts’
fair
value
estimates.

In
the
final
months
of
the
year,
the
market’s
rally
did
broaden
beyond
the
Magnificent
Seven.
However,
this
small
group
of
stocks
was
still
responsible
for
47.8%
of
the
US
Market
Index’s
26.5%
gain.

On
the
other
side
of
the
fence,
2022’s
leaders
were
left
in
the
dust
in
2023.
The
biggest
performance
differential
came
among
energy
stocks.
The Morningstar
US
Energy
Index surged
62.5%
in
2022,
but
in
2023,
the
sector
barely
held
in
positive
territory
as
oil
prices
slid.
While
many
energy
stocks
had
pushed
into
overvalued
territory
as
a
result
of
the
2022
rally,
the sector
is
now
broadly
undervalued.

Utilities
struggled
too,
mainly
because
of
rising
interest
rates,
which
lifts
their
cost
of
capital
and
offers
competition
in
the
form
of
higher
bond
yields.
Before
rallying
off
their
worst
levels,
the
sector
overall
was
at
its
cheapest
level
since
2008,
according
to
Morningstar
analysts.
Now
the
group
is
more
fairly
valued,
but dividend
yields
are
still
seen
as
attractive.

Value
Stocks
vs.
Growth
Stocks

Along
with
the
massive
rally
in
tech
and
communications
services
stocks,
growth
stocks
more
broadly
put
in
their
strongest
performance
in
25
years.
One
catalyst
was
the
shifting
outlook
for
interest
rates.
The
valuations
for
growth
stocks
are
highly
dependent
on
the
value
investors
attach
to
future
earnings.
As
a
result,
rising
rates
drag
on
growth
stocks
because
they
make
those
future
earnings
less
valuable.

But
with
the
Fed
now
expected
to
cut
rates
in
2024,
that
headwind
has
been
reduced.
The
resulting
rally
led
the Morningstar
US
Large
Growth
Index to
its
biggest
gain
since
1998, one
which
outperformed
the Morningstar
US
Large
Value
Index by
35
parentage
points,
which
is
the
second-largest
margin
of
the
past
decade, coming
in
just
behind
2020’s
returns.

For
most
of
2023,
the
stock
market’s
rally
was
dominated
by
large-cap
stocks,
as
smaller
stocks
were
held
back
by
fears
of
recession
and
higher
interest
rates.
Small
value
in
particular
lagged
for
the
first
three
quarters
of
the
year.

However,
with
the
economy
holding
strong,
as
the
Fed
signaled
its
shift
toward
expecting
cut
rates,
small-company
stocks
staged
big
gains
in
the
final
two
months
of
the
year.
During
the
fourth
quarter,
the
Morningstar
Small
Value
Index
posted
its
best
quarterly
gains
since
the
first
three
months
of
2021.

Dividend
Stock
Performance

For
dividend
stocks,
the
story
was
one
of
multiple
headwinds
coming
together
to
depress
performance.
The
regional
banking
crisis
took
its
toll,
thanks
to
heavy
bias
among
dividend
strategies
toward
financials.
Bigger
holdings
of
energy
stocks
and
utilities
also
were
a
drag
on
performance.

The Morningstar
Dividend
Composite
Index – a
broad
measure
of
dividend
stock
performance –
fared
best
among
Morningstar’s
main
dividend
benchmarks,
thanks
to
a
relatively
heavy
weighting
in
technology
stocks,
at
nearly
18%
of
the
portfolio.
(The
Morningstar
US
Market
Index
is
nearly
30%
tech
stocks.)

In
contrast,
the Morningstar
Dividend
Leaders
Index –
a
collection
of
the
100
most
consistently
paying,
highest-yielding
stocks –
has
just
5%
of
its
weight
in
tech
stocks.
That
index
brought
up
the
rear
in
2023,
failing
to crack
even
a
4%
return
for
the
year.

The
Fed
and
Bond
Yields

Far
and
away,
the
biggest
story
for
the
markets
in
2023
was
Fed
policy.
But
as
is
often
the
case,
it
was
more
about
investor
expectations
than
what
the
Fed
actually
did.

As
the
year
got
underway,
the
Fed
shifted
from
its
unprecedented
series
of
three-quarter-of-a-percent
increases
in
its
federal-funds
rate
target
range
during
2022
to
more
traditional
quarter-point
moves.
By
May,
the
Fed
had
raised
three
times
that
year,
taking
that
target
range
to
5.00%-5.25%.
When
officials
met
in
mid-June,
officials
held
policy
steady
for
the
first
time
since
the
hiking
cycle
began
in
March
2022.
However,
Fed
officials
stressed
that
“higher
for
longer”
was
the
likely
course
for
interest
rates.

In
the
background,
inflation
was
still
elevated
and
job
gains
were
strong,
but
with
rates
having
been
raised
aggressively,
officials
signaled
a
desire
to
give
tighter
policy
a
chance
to
work.
The
Fed
raised
rates
again
in
July,
taking
the
funds
rate
target
range
to
5.25%-5.50%.

In
the
bond
market,
yields
followed
an
arc
sharply
higher
and
then
lower
over
the
year,
in
what
turned
out
to
be
a
round
trip
for
some
parts
of
the
US
Treasuries
market.

The
yield
on
the
US
Treasury
10-year
note
(which
serves
as
a
key
benchmark
for
most
home
mortgages
and
other
consumer
and
business
loans)
started
the
year
near
3.8%,
and
for
the
first
seven
months
of
2023,
it
bounced
back
and
forth
within
a
relatively
tight
range.

However,
in
early
August,
Treasury
bond
yields
spiked
in
response
to
news
that
the
federal
government
had
a
larger-than-expected
need
to
borrow
money
through
bond
sales
in
the
third
quarter,
rumblings
of
higher
rates
in
Japan,
and
data
showing
a
red-hot
jobs
market.
This
sent
the
yield
on
the
10-year
note
to
a
17-year
high
of
roughly
5%
from
just
below
4%
on
July
31.

Then,
just
as
quickly,
that
sell-off
was
reversed
as
data
showed
the
jobs
market
was
finally
moderating
from
the
pace
of
hiring
seen
for
most
of
the
year.
In
addition,
inflation
news
continued
to
be
favorable.
When
the
Fed
confirmed
it
expected
to
pivot
to
rate
cuts
in
2024,
bonds
rallied
strongly.

Treasury
Yield
Curve
Inversion

Another
aspect
of
the
market
that
looks
strikingly
similar
at
year-end
to
the
way
it
did
at
the
start
is
the
inverted
US
Treasury
yield
curve.

When
short-term
Treasury
yields
exceed
long-term
yields,
it’s
known
as
an
inverted
yield
curve,
and
this
is
widely
seen
as
a
precursor
to
a
recession.
(Not
all
yield
curve
inversions
lead
to
recessions,
but,
historically,
all
recessions
have
been
preceded
by
one.)
Many
analysts
say
the
longer
the
yield
curve
remains
inverted,
the
more
likely
a
recession
becomes.

The
yield
curve,
as
measured
by
the
gap
between
yields
on
the
Treasury
2-year
and
10-year
notes,
has
been
steadily
inverted
since
July
2022.
This
was
the
result
of
the
Fed’s
aggressive
effort
to
raise
the
federal-funds
rate,
which
lifted
short-term
yields
well
above
long-term
yields.

Looking
at
recent
history,
this
17-month
inversion
is
second
in
length
only
to
the
period
of
August
1978
through
April
1980,
which
ended
while
the
economy
was
in
recession.

Over
2023,
the
extent
of
the
inversion
has
swung
widely.
To
start
the
year,
2-year
notes
yielded
about
0.5
percentage
points
above
the
10-year
note.
Twice
during
the
year,
that
gap
widened
to
roughly
a
full
percentage
point,
which
by
historical
standards
is
an
extremely
large
difference.
During
the
bond
market
sell-off
in
October,
the
yield
curve
flattened
out
toward
a
0.2-percentage-point
difference
for
2-year
notes
over
10-year
notes.
By
year-end,
the
yield
curve
was
inverted
by
roughly
0.4
percentage
points.

2023
Bond
Market
Performance

While
most
of
the
attention
was
on
the
Fed’s
plans
for
interest
rates
and
the
wild
swings
in
long-term
Treasury
bond
yields,
when
it
came
to
actual
returns,
the
action
was
elsewhere.
By
far,
the
best
returns
came
on
credit-sensitive
portions
of
the
bond
market.

Several
factors
boosted
returns
on
the
credit
markets.
The
first
was
the
unexpected
strength
of
the
economy.
As
the
year
wore
on
and
it
became
clearer
that
we
would
avoid
recession,
that
lessened
the
perceived
risks
of
default
on
bonds
issued
by
riskier
borrowers.

Second,
many
lower-quality
borrowers
had
taken
advantage
of
the
long
period
of
extremely
low
interest
rates
to
issue
longer-maturity
debt.
That
meant
that
even
with
interest
rates
higher
than
they
have
been
in
many
years,
those
borrowers
weren’t
as
likely
to
face
a
cash
crunch
brought
on
by
having
to
issue
debt
at
levels
they
couldn’t
afford.

Meanwhile,
the
strong
gains
in
the
stock
market,
along
with
the
friendly
Fed,
engendered
a
so-called
“risk
on”
mentality,
wherein
investors
were
more
willing
to
venture
into
lower-quality
debt.

As
a
result,
for
the
second
year
running,
leveraged
loans
were
a
top-performing
group
within
the
bond
market.
Leverage
loans
had
the
benefit
of
both
the
favorable
backdrop
for
credit
conditions
and
their
historical
bias
toward
performing
well
in
rising
rate
environments,
thanks
to
the
floating-rate
nature
of
the
underlying
debt.

2023’s
Best
and
Worst
Market
Performers

It
was
a
good
year
for
technology
stocks,
no
matter
how
you
sliced
it.

Even
when
pulling
back
the
lens
globally,
across
asset
classes
and
sectors,
technology
names
(semiconductors
in
particular)
dominated
the
performance
charts
in
2023.
Driving
this
rally
was
the
emergence
of
AI
as
a
transformative
technology
requiring
massive
new
computing
power.

Even
as
much
of
the
broader
stock
market
marched
higher
over
the
year,
one
group
was
unable
to
erase
its
early
massive
losses:
regional
banks.

The Morningstar
US
Banks-Regional
Index was
down
as
much
as
36%
in
May
after
the
collapse
of
Silicon
Valley
Bank,
and
even
over
the
summer
it
was
still
posting
double-digit
losses.
It
was
only
with
the
signals
from
the
Fed
that
rate
cuts
could
be
coming
in
2024 –
which
would
relieve
the
pressure
on
these
banks’
balance
sheets –
that
the
index
closed
its
losses
to
single
digits
for
the
year.

Bottom-ranked
performers
also
include
China
stocks,
where
equities
are
posting
their
third
consecutive
year
of
losses.
Sentiment
among
investors
has
been
soured
by
a
combination
of
slowing
economic
growth,
ongoing
financial
strains
in
the
country’s
real
estate
sector,
and
a
heightened
wariness
among
some
investors
about
the
geopolitical
risks
involved
with
owning
China
stocks.

Stock
and
Bond
Market
Volatility

The
past
year
was
a
reminder
that
volatility
captures
both
market
plunges
and
big
market
rallies.

Even
as
stocks
and
bonds
posted
gains
for
the
year,
volatility
was
elevated –
especially
in
the
bond
market,
which
saw
a
tremendous
whipsaw
in
prices
during
the
fourth
quarter.

Driving
the
volatility
was
the
back
and
forth
over
the
outlook
for
the
Fed.
During
the
fourth
quarter,
as
the
Treasury
bond
market
swung
from
a
big
sell-off
into
a
sharp
rally,
volatility
jumped
to
its
highest
level
in
at
least
five
years.

2023
Currency
Market
Performance

For
much
of
the
year,
the
story
in
the
currency
markets
was
the
strength
of
the
dollar,
especially
against
the
Japanese
yen.
With
the
Fed
continuing
to
raise
rates
and
the
Bank
of
Japan
doing
little
more
than
signaling
a
slight
bias
toward
higher
rates,
the
dollar
gained
nearly
16%
against
the
yen
by
the
middle
of
November.
It
was
only
in
the
final
weeks
of
the
year,
after
the
Fed
signaled
its
pivot
to
lower
rates,
that
the
dollar
fell
back
against
the
yen.
Still,
the
dollar
finished
2023
up
nearly
8%
against
the
yen.

The
greenback
also
held
firm
against
the
euro,
with
expectations
that
the
European
Central
Bank
will
need
to
cut
rates
in
2024
largely
offsetting
similar
expectations
for
the
Fed.

2023
Commodity
Markets
Performance

In
commodities,
geopolitical
risks
continued
to
hover
over
the
oil
market,
but
it
was
slowing
demand
that
drove
prices
in
the
end.
Oil
prices
spiked
in
October
in
the
wake
of
the
outbreak
of
war
between
Israel
and
Hamas,
but
quickly
fell
back.
That
slump
came
despite
concerns
over
OPEC
output
cuts
by
Russia
and
Saudi
Arabia.

Gold
prices
ended
2023
near
a
new
record
high
hit
in
early
December.
Driving
prices
higher
have
been
a
combination
of
concerns
about
geopolitical
risks,
such
as
an
expanding
war
in
the
Middle
East,
and
the
prospects
of
lower
interest
rates
in
the
United
States.

Meanwhile,
copper
seesawed
in
2023,
but
it
finished
the
year
slightly
higher.
With
copper
seen
as
a
reflection
of
global
economic
activity,
prices
have
been
capped
by
concerns
about
the
health
of
the
Chinese
economy
and
expectations
for
slower
growth
in
the
U.S.
in
2024.

2023
Cryptocurrency
Performance

Cryptocurrencies
roared
back
to
life
in
2023,
despite
continuing
scandals
in
the
industry.
Both
Bitcoin
and
Ether
lost
more
than
half
their
value
in
2022,
but
their
prospects
revived
on
expectations
that
the
Securities
and
Exchange
Commission
is
drawing
closer
to
approving
exchange-traded
funds
based
on
spot
cryptocurrency
trading.

In
addition,
both
currencies
gained
in
strength
as
investors
viewed
the
Fed’s
expected
rate
cuts
as
a
positive.