Around this time last year, 85% of economists predicted a recession for 2023. The growth they expected in America over the next calendar year was the fourth-lowest in 55 years.

Defying these predictions, the S&P 500 concluded the year at an impressive 4,770 points, outperforming the price targets of every major Wall Street firm by a notable margin of over 200 points. The S&P 500’s actual price gain of 24% was over 18% higher than the average forecast, marking yet another triumph for market optimists.

In line with this narrative, the US Unemployment Rate and the Volatility Index (along with the Gold/Oil Ratio) are at record lows.

Let's take a closer look at the US Stock Market itself. First, let's look at valuations. The Buffett Indicator (Market Cap to GDP) is just below its November 2021 peak and the Shiller PE Ratio stands at 30.97.

In 2023, there was a dramatic shift in Sector Performance compared to 2022. The sectors that led the market in 2022 - Energy, Utilities, and Consumer Staples - found themselves at the bottom of the rankings in 2023. Conversely, the sectors that were lagging in 2022, namely Tech, Communications Services, and Consumer Discretionary, emerged as the top performers in 2023.
In aggregate, Cyclical Sectors have outperformed Defensive Sectors throughout the year and the ratio is close to its 2000 and 2021 peak.

Looking at different segments of the US Stock Market, the Nasdaq outperformed the S&P 500, Growth Stock outperformed Value Stocks, Large-cap Stocks outperformed Small-cap Stocks, and the Market-cap outperformed the Equal-Weighted Portfolio.

Internationally, the US continued to outperform the rest of the World and it now makes up 62.57% of the MSCI ACWI Index. Incredibly, the Magnificent Seven alone have a higher weighting in the index than all of the stocks in the UK, China, France and Japan combined.

In aggregate, Emerging Markets continued to underperform Developed Markets nearing the 2001 lows.

Looking at the MSCI Factor Indices, similar to the US Sector dynamics mentioned above, the worst performing factors of 2022 (including Quality and Growth) turned out to be the best performing ones of 2023.

Looking at Country Indices over the last 8 year, Denmark stands out at +139.75% (largely driven by Novo Nordisk) and Taiwan at +143.29% (largely driven by tsmc).

Since the last newsletter, the Indian Stock Market continued to outperform the Chinese one.

As of 2022, the Chinese nominal GDP reached $17.96T while US GDP climbed to $25.44T.

How come this economic growth has not translated in stock market returns?

Hsu et al. (2022) found that there is no reliable link between GDP growth and stock returns. Instead, what matters more to investors are the growth in earnings per share (EPS) and dividends per share (DPS) of listed companies. So what happened to earnings per share in China?

According to Alex King and Supriya Menon from Wellington Management, GDP growth in China did not translate into EPS. But why not?

The main reason is Equity dilution. In China, earnings per share have been diluted over the years by an increase in sharecount due to capital raises. In stark contrast, in the United States, companies frequently buy back their shares, reducing the total number in circulation. This action helps to increase the EPS, as the earnings are now divided among fewer shares. In theory, raising capital through share issuance can enhance EPS if the funds are used efficiently. Unfortunately, this hasn't been the case with many EM/Chinese companies.

The Yield Curve, which is often considered to be a predictor of an economic recession started rising from the deepest inversion seen since 1981 and then reversed.

This was due to long-term yields falling and then rising again, while the 3-month short-term rate stayed constant.

M2 yoy growth bottomed at -4.78% after it hit 26.81% in 2021. CPI Inflation peaked in June 2022 at 9.06% and has been somewhat stable at around 3.2% since May 2023.

The Real Interest Rate is once again positive at 1.69% with CPI Inflation at 3.3% and the nominal interest rate of a 1-year US Treasury bond at 4.82%.

Gold broke out above the resistance of $2000 despite rising real rates.

Bonds suffered since yields started to rise in early 2022, but they started to recover and so did the 60/40 Portfolio.

Addressing the debt crisis remains a long-term challenge. The US National Debt soared by $2.5 trillion in just seven months, doubling in a decade.

With rising yields, this debt is becoming increasingly expensive to service. According to the CBO and Committee for a Responsible Federal Budget, last year, the federal government spent more on interest than on children or on Medicaid. Spending on interest is on track to become the largest government program, surpassing Social Security at 6.2% of GDP by 2051.

Interest burdens are increasing not only for governments but also for companies and households. Grant Williams highlights how this escalation in financial pressure is leading to intensified social tensions and potential conflicts, particularly as people struggle with the effects of inflation and a widening wealth gap. Williams expresses concern about the upcoming election, emphasizing the dire need for strong, pragmatic, and principled leadership in Western democracies to navigate these challenges.
In line with this view, Ray Dalio underscores the necessity for smart, bipartisan leadership as a critical response to these economic and social pressures. Dalio believes that addressing these issues effectively requires more than just economic policy changes; it demands political leaders who are capable of bridging partisan divides.
Ray Dalio anticipates another round of quantitative easing (or QE), in which the FED buys government bonds and increases the Money Supply. He suggests that this continued intervention will be necessary to manage the growing debt service costs and budget deficits that governments are grappling with.

In 2023, mortgage rates rose and peaked in October at 7.79%. They rose faster than other yields leading to the largest spread relative to Treasuries since 2008.

Despite rising mortgage rates, and rising Housing Payments relative to Incomes, Home Prices remained high, with the average cost now exceeding seven times the median household income.

As there are few buyers capable of affording these high prices, the volume of transactions for existing homes has plummeted to its lowest point since the global financial crisis.

On the other side of the Atlantic, thinks look different. German Residential Property Prices have come down by 15% compared to last year.

In recent news, the U.S. Securities and Exchange Commission (SEC) approved the first spot Bitcoin ETF, enabling investors to directly invest in Bitcoin, rather than using crypto exchanges or engaging in futures contracts.

Year-over-year, the price of Bitcoin rose by 144.91% and Bitcoin Dominance (relative to the other cryptocurrencies) rose from 41% to 51.59%.

Disclaimer: All information provided is for educational purposes only and does not constitute investment, legal or tax advice, or an offer to buy or sell any security. Read our full Terms of use here.