Coming off one of the worst years in recent history, it’s no question 2023 has been a better year for the markets so far than 2022. Overall, we’ve seen a positive skew among most asset classes, compared to mostly negative data last year. However, as is often the case, not everything is up equally. But it may come as a surprise as to the significant discrepancy between the leaders and laggards this year, a situation that can make being a smart, well-diversified investor frustrating in the short-term
Depending on what you are using as a benchmark for the “markets” will dictate what you believe the markets are up this year. Many people inherently use the S&P 500 as a market proxy, as it’s relatively easy to understand and the news covers the largest companies in the Index often - it’s familiar. The S&P 500 is having a pretty good year too, up 10.29% year-to-date (including dividends) through May 26.¹
Interestingly enough, approximately 95% of the return of the S&P 500 is coming from just three (3) companies - Apple, Microsoft, and Nvidia. These three companies themselves have added about 9.83% to the S&P 500’s return of 10.29%. However, returns of the companies outside of these three are much more modest, with a median return of just 0.45%. On top of that, only 235 of the companies in the Index are positive - so over half the companies are in the red so far in 2023.²
It’s apparent that a handful of companies are leading the way here, but what does that mean for other segments of the market outside of just large-cap US stocks? Here’s a rundown of where other areas of the market are sitting through late May.
A few things that stand out:
-The spread between the Nasdaq 100 and commodities is 39.80%. A huge disparity only 5 months into the year.
-Most asset classes are positive, but it’s clear a couple stand out significantly above the rest.
-An equally balanced portfolio of these asset classes would be up just 4.67% so far YTD. Not bad compared to last year, but not quite what we’re seeing on the news with the focus on large-tech (this isn’t even factoring in bonds or other fixed-income asset classes, which are mostly up in the 1-2% range).
With this data, some might wonder why anyone would hold anything other than large-cap tech stocks when looking for growth. Outside of 2022, large tech has had a strong run, pulling the markets higher with it. Does it ever make sense to hold anything else?
Let’s take a look at how various asset classes have done over time using a useful tool called the Callan Periodic Table of Investment Returns. This table illustrates various asset class returns for each calendar year from 2003 - 2022.
There are a few key takeaways we can note here:
-Large-cap US stocks have dominated the past 10 years from 2013 - 2022. The asset class has been in the top three of the chart in 8 of the past 10 years (exceptions being 2018 and 2022). This is largely due to the same trend we’ve seen so far in 2023 - larger tech companies leading the way higher.
-Large-cap US stocks lagged the prior 10 years from 2003 - 2012. The asset class wasn’t in the top three of the chart even once in that 10 year period. During this time, emerging markets, developed international, and REITs dominated the markets.
-The average divergence between the top and bottom performer each year is 35.39% (It was as high as 78.30% in 2009 and as low as 16.30% in 2015). There’s always something doing better and something doing worse than average, and the spread is often quite large.
-If we invested all of our money in a single asset class, there would be a higher chance of either being near the top or the bottom of the list in any given year. Including various asset classes provides more portfolio stability by reducing the potential for both large losses and large gains.
To dive in a bit deeper, below is another graphic to help illustrate the divergence between growth and value stocks over time, specifically.
Since the early 1980’s, the total return of the Russell 1000 Growth Index and the Russell 1000 Value Index are relatively similar (both close to 12% annualized), and each has had its moments of outperformance and underperformance. Generally, when markets are volatile we see value stocks bring more stability. On the flip side, growth stocks have led the way during the most recent bull run as mentioned above. Last year showed a scenario similar to the inflationary and rising rate environment of the early 80’s as value outperformed by a wide margin, but growth has come back with a vengeance in recent months - very different from what we saw 40 years ago.
Markets are cyclical and diversification is important. It can be tempting to think “what if” when watching an asset class soar higher while others are lagging behind. However, it’s important to maintain discipline and not chase returns, as this can increase portfolio risk unnecessarily. History shows it’s normal to see a wide divergence between the market leaders and laggards, and they can quickly change places. We’ve seen this take place first hand with many trend changes between 2020 - 2023.
It makes sense to have some exposure to these giant tech companies that are leading the way higher in 2023. However, it makes sense to have exposure to other areas as well, in case things don’t play out exactly how analysts are expecting them to. They rarely ever do - just look at the metaverse hype from a couple years ago, or Cathy Wood’s ARK Innovation ETF’s meteoric fall from grace.
Last year’s laggards have quickly become this year's leaders and vice versa. For example, even after the 30%+ rally in the Nasdaq 100, it’s still 13% below its all-time-high due to the sharp losses experienced last year, so there’s still some room to add exposure if the rebound continues. On the other end, high-dividend stocks were flat last year, but are lagging so far in 2023.
Broadly speaking, we’ve seen some shifts in our models toward more growth oriented asset classes in recent months, but it can take time for these adjustments to fully play out. With the narrow market leadership and some lingering economic uncertainties, many models have favored a more blended allocation among various asset classes, so as to not put too much emphasis on one area of the market. The past five months of data is enough to merit some initial adjustments, but not enough to completely compensate for the volatility experienced throughout last year.
Investing for retirement should be like watching the grass grow, or watching paint dry. It’s not supposed to be exciting, as that excitement can quickly shift to fear when market conditions change. But if you’re patient and methodical, most often you will be better off over the long run.
¹ Data from Morningstar
² Data from Slickcharts