The U.S. (and many global) economies were able to finish out 2023 without the dreaded “R” word (recession) despite the vast majority of economists and strategists calling for one at the beginning of the year. How did this happen when most leading economic indicators and economic models pointed to a hard landing? First, the traditional business cycle, of which many economists built their models and where economic indicators are typically more predictive, was significantly disrupted by the economic shutdown of 2020. We think a more appropriate comparison to our current economic environment is a post-war recovery when the government implements massive stimulus and there is significant pent-up demand coming off such uncertainty in everyday life. Another factor that many forecasters got wrong was the resilience of the U.S. Consumer. Recession predictions relied on rising interest rates that would kill demand for consumer spending and businesses halting capital expenditures. While consumers did spend down their excess savings, given a robust job market and real wages continuing to grow, people did not feel as compelled to change their spending habits because they recognized their personal financial situation as relatively stable.
Markets ended 2023 on a high note with global equities up just north of 11% for the quarter ending December 31st. Even more encouraging was the broad rally we saw in the fourth quarter during which small caps, represented by the Russell 2000, outperformed large caps with a 14%+ return. A major storyline of equity investing this year was the dominance of the “Magnificent 7” (Microsoft, Apple, Amazon, Google, Nvidia, Tesla, and Meta). The index construction of many popular benchmarks (S&P 500, MSCI ACWI, etc.) has led to these few companies becoming massive allocations (roughly 30% for the S&P 500). The contribution of those seven companies to the total return for the S&P 500 was roughly 2/3rds for 2023, so one can see how being underweight, to any degree, in those few names may have led to relative underperformance this past year. Another surprise in the market was fixed income. Coming off its worst year in 2022, fixed income was expected to have a banner year. Interest rates continued to rise throughout the majority of the year, with the 10-year treasury yield peaking at around 5% in the middle of October, before reversing significantly in the last 2 months of the year back to essentially where yields started 12 months prior. While returns were broadly positive for fixed income to the tune of their initial starting yields, 2023 was very much a roller coaster ride for bonds.
Looking forward to 2024, and beyond, we are optimistic about the path for the economy and markets. Inflation continues to cool down and is now close to the Fed’s target based on shorter look-back periods. Market and Fed expectations for interest rates signal rate cuts in 2024, which will be a welcomed relief for homebuyers and businesses relying on financing. Earnings are expected to grow in 2024 after broadly contracting in late 2022 and 2023. Given that valuations for large swaths of the market (ex-Magnificent 7) are still reasonably relative to historical averages, we believe 2024 could be a very strong year for diversified portfolios.
Equity Sleeve: We continue to maintain a mix of active and passive strategies across our equity exposures. While international equities look attractive with the backdrop of lower relative valuations and higher relative yields, we still favor an overweight to US Stocks and Large Cap Growth stocks in particular. We continue to maintain a small allocation to Small and Mid Cap Stocks as they exhibit historically low relative valuations to other equity asset classes.
Fixed Income Sleeve: Over the last quarter, we increased our allocation to more defensive areas of the fixed income universe by highlighting high credit quality and moderate interest rate sensitivity. Fixed Income continues to experience volatility as bond markets anticipate how many Fed cuts to expect in 2024. In the aftermath of significant inflation and a historically fast rate hiking cycle, fixed income now looks poised to contribute positively to portfolios with attractive yields not seen in decades and the potential for price appreciation. However, potential risks within credit markets and rate volatility remain.
Alternative Fixed Income Sleeve: To further diversify the fixed income portion of portfolios, we continue to rely on an Alternative Fixed Income Sleeve which is meant to provide fixed income like returns and risk utilizing non-traditional strategies that are less exposed to interest rate risk. This strategy is meant to complement, not replace your traditional fixed income strategy as we aim to produce meaningful real returns while maintaining the primary focus of fixed income which is diversification from stock volatility.
Risk Mitigation Sleeve: The risk mitigation sleeve provides an additional form of downside risk management clients who are in the preservation or distribution stage. Rather than relying solely on fixed income to reduce portfolio risk, the sleeve utilizes various differentiated risk mitigation strategies that complement each other to create an approach that focuses on downside risk protection first while allowing for moderate participation in rising markets. The Risk Mitigation sleeve was very defensive in the face of the market selloff in 2022, with some of the underlying strategies becoming increasingly defensive as the selloff intensified. In 2023, the Risk Mitigation sleeve has captured a moderate amount of the upside as certain tactical strategies have added more equity exposure. We expect this sleeve to be a continued source of diversification and downside protection.
Past performance is not indicative of future results. The investments recommended by Horizon are not guaranteed. There can be economic times when all investments are unfavorable and depreciate in value. Clients may lose money. This information should not be considered a recommendation to buy or sell any security or adopt a particular investment strategy. Any information about performance, allocations, and contributors and detractors is illustrative of Horizon’s model strategies and is therefore hypothetical and not representative of any specific account. It should not be assumed that any of the transactions, holdings, or sectors discussed were or will be profitable or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance discussed herein. Opinions referenced are as of the date of publication and may not necessarily come to pass. Forward looking statements cannot be guaranteed. We do not intend and will not endeavor to provide notice if and when our opinions or actions change. References to indices, or other measures of relative market performance over a specified period of time are provided for informational purposes only. Reference to an index does not imply that the any account will achieve returns, volatility or other results similar to that index. The composition of an index may not reflect the manner in which a portfolio is constructed in relation to expected or achieved returns, portfolio guidelines, restrictions, sectors, correlations, concentrations, volatility or tracking error targets, all of which are subject to change. Information obtained from third party sources is believed reliable but has not been vetted by the firm or its personnel.
Any risk management processes described herein include an effort to monitor and manage risk, but should not be confused with and do not imply low risk or the ability to control risk.
The commentary in this report is not a complete analysis of every material fact in respect to any company, industry, or security. The opinions expressed here are not investment recommendations, but rather opinions that reflect the judgment of Horizon as of the date of the report and are subject to change without notice. Forward-looking statements cannot be guaranteed. We do not intend and will not endeavor to provide notice if or when our opinions or actions change. This document does not constitute an offer to sell or a solicitation of an offer to buy any security or product and may not be relied upon in connection with the purchase or sale of any security or device.
The Russell 2000 Index is a small-cap U.S. stock market index that makes up the smallest 2,000 stocks in the Russell 3000 Index. The S&P 500 or Standard & Poor's 500 Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies. The MSCI All Country World Index (ACWI) is a global equity index that measures the equity performance in both the developed and emerging markets. References to indices, or other measures of relative market performance over a specified period of time are provided for informational purposes only. Reference to an index does not imply that any account will achieve returns, volatility, or other results similar to that index. The composition of an index may not reflect the manner in which a portfolio is constructed in relation to expected or achieved returns, portfolio guidelines, restrictions, sectors, correlations, concentrations, volatility or tracking error targets, all of which are subject to change. It is not possible to invest directly in an index. This commentary is based on public information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such.
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