Buoyed by a resilient economy, solid corporate earnings, and hopes for an end to Federal Reserve rate hikes, US equities registered double-digit returns, as the Morningstar US Market Index gained 26.4%. While fears of “higher-for-longer” interest rates led markets lower during the third quarter, equities rallied in November on growing anticipation for interest rate cuts as inflationary pressures began to slow.
Cyclical and economically sensitive stocks outperformed during 2023, led by technology stocks. Fueled by artificial intelligence enthusiasm and heavily influenced by mega-cap growth stocks, the Morningstar US Technology Index advanced 59.1%. Several high-profile media stocks, also part of the “Magnificent Seven,” boosted the communication services sector, with the Morningstar US Communication Services Index adding 46.1% for the 1-year period.
Defensive sectors, including healthcare and consumer defensive, lagged the broader market as investors turned to high-growth names. The utilities sector faced additional headwinds due to higher interest rates, and the Morningstar Utilities Index posted a 7% loss. The energy sector, as measured by the Morningstar US Energy Index, also declined for the year, succumbing to demand fears from a weaker-than-expected recovery in China and higher supply inventories.
Source: Morningstar Sector Indexes; Data as of December 31, 2023.
Dovish Fed Sends Equities Higher for the Quarter
During the fourth quarter, the Morningstar US Market Index gained 12.1%, with solid performance across most sectors. While stocks declined in October, cooling inflation data and a slowing labor market raised expectations for a soft landing, sparking a November rally. In particular, anticipation for a Fed pivot to lower interest rates helped the interest-rate sensitive real estate sector outperform for the quarter, as the Morningstar US Real Estate Index rebounded 17.9%, erasing its year-to-date losses. Technology stocks also outperformed for the fourth quarter, as the Morningstar US Technology Index extended its gains by 17.2%.
Energy was the lone sector to post negative returns for the quarter and the Morningstar US Energy Index declined 6.3%. Prices of both natural gas and oil prices dropped on fears of oversupply, offsetting initial volatility over the war between Hamas and Israel.
Market Breadth Expands Beyond Technology Stocks in the Fourth Quarter
The narrowing of market returns and the dominance of the mega-cap growth stocks can be clearly seen when looking at the impact of these companies on equity performance. Through the end of October, the US Target Market Exposure Equal Weighted Index was dominated by the top 10 stocks, which contributed to almost 88% of the returns.
When comparing the Equal-Weighted Index to the market capitalization-weighted Morningstar US Target Market Exposure Index, the influence of these stocks is again emphasized. The Equal-Weighted Index severely lagged its market-cap weighted peer for the majority of 2023, declining 0.2% versus a 10.6% gain through October 31.
The tide shifted following the November rally, leading the Equal-Weighted Index to pull ahead of the Target Market Exposure Index through year-end. Market breadth widened, and the contribution to index returns from the top 10 contributors dropped to under 62%.
Source: Morningstar Direct; Morningstar Investment Management LLC analysis. Data as of December 31, 2023.
Read the full Morningstar Markets Observer Q1 2024.
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