In Short

• U.S. economic strength, a resilient labor market and a confident consumer buoyed generally strong market performance as inflation steadily retreated during the year but remained above the Federal Reserve’s (Fed) long-term goal
• We see potential in last year’s laggards as they may represent contrarian investment opportunities that active managers may look to in their search for quality companies
• While we believe that inflation may continue to subside and that the Fed may cut rates in 2024, uncertainties to consider include the lagging impact of rate hikes and geopolitics
• We favor reviewing your long-term asset allocation to ensure it is in line with your investment goals and objectives

That’s a Wrap

Markets closed out 2023 with generally strong returns across the board. Though investors faced various challenges, including the regional banking scare in March, geopolitical tensions and hawkish central bank policy, financial conditions held relatively steady, with signs of loosening emerging at year-end. The Dow Jones Industrial Index hit a fresh all-time high and the S&P 500 Index neared its January 2022 peak to close out the index’s best December since 2010. Fixed income, as measured by the Bloomberg Aggregate Bond Index, had its best fourth quarter in 34 years.

The strength of the U.S. economy, a resilient labor market and a confident consumer willing to spend down excess savings helped buoy both equity and fixed income performance as inflation steadily retreated against a backdrop of restrictive monetary policy. Coming into last year, both the bond and equity markets were pricing in potential interest rate cuts in the back half of 2023, but it became clear as the months progressed that the Federal Reserve would be steadfast in its hawkish policy given robust economic growth and stickier-than-expected inflation. As 2023 concluded, however, the Fed held its policy rate steady at a range of 5.25 – 5.50% (a 22-year high) and indicated through both messaging and the December “dot plot” that we may be at the peak of this hiking cycle. As it stands, the market anticipates six 25-basis-point cuts in 2024, leaving the policy rate at a range of 4.00 – 3.75% by December 2024’s meeting, suggesting perhaps an even more dovish pivot than telegraphed by the Fed itself.

Market-Implied Federal Funds Rate

Source: Bloomberg, as of December 31, 2023.

All the while, the “Magnificent Seven” stocks had a banner year, returning roughly 73% as a basket of stocks. As of the end of 2023, these seven names made up more than a 28% weighting of the S&P 500 Index. Due to their high concentration in the index, Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVIDIA and Tesla drove 62% of the S&P 500’s Index return in 2023. In our Halftime Report, we mentioned a potential broadening of the market rally to the rest of the index. Though the rest of the index marginally outperformed the top seven stocks in June, further signs of broadening did not appear until after the peak in U.S. yields in late October, after which the equally weighted S&P 500 Index outperformed the seven top stocks through the end of the year. Given that the S&P 500 index is currently trading at an average forward price/earnings ratio of 21.1 compared to the forward P/E of the top seven stocks at 29.6, our view is that there might be better opportunity for capital appreciation given that the Magnificent Seven could be more vulnerable to multiple compression or stagnation in price momentum following 2023 results.

Despite these strong returns, we must note that two-year returns are much more muted. Over a two-year time period, the S&P 500 Index is up just 3.4%, while the top 10 stocks have returned 5.3%. Though 2023 was a very strong year for both, we believe that we are essentially back to where we started at the beginning of 2022. Interestingly, the best-performing asset classes over the two-year time period were cash and commodities (including energy), though commodities were significant stragglers in 2023.

Laggards Find (Relative) Favor

As we move forward into the new year, we see potential opportunity in last year’s laggards. Laggards can often represent contrarian investment opportunities. In this instance, they may have priced in economic conditions that were more negative than reality, or the prevailing consensus might be so pessimistic that even a smaller positive change in fundamentals could result in outperformance. We believe that investors, as they look to deploy cash in 2024, may begin to rotate to these more attractively priced areas of the market.

When considering these potential opportunities, we remain focused on quality but recognize that certain regions (developed over emerging markets), styles (growth over value), and size (large cap over small caps) have been in favor, and that markets with a greater degree of pessimism priced in are likely to perform better than those potentially “priced for perfection.” Among these areas of opportunities are two sub-asset classes that were recently upgraded by our Asset Allocation Committee: U.S. small caps and commodities, both of which appear to have been priced for a hard-landing scenario.

Although we believe that inflation may continue to subside and that the Fed may cut rates in 2024, there are still some uncertainties to consider. Among those is the lagging impact of previous rate hikes, which have the potential to restrict capital expenditures and growth given the higher burden of borrowing costs. In addition, as outsized savings are expended, consumers may continue spending at similar levels with higher credit-card and auto-loan interest rates than those afforded before the pandemic.

Geopolitics are also expected to play a significant role in the markets in the new year. Broadly, important elections will take place in countries and regions making up over 50% of global GDP in 2024 including Taiwan, Russia, India, Mexico, the European Union and the United Kingdom. In the U.S., it is a presidential election year, which has historically shown a pattern of performance within equities: a weak start, a rally into the fall, volatility as election day draws near, and a post-election rally. Given all the unusual aspects of the 2024 race, it seems appropriate to think of the political backdrop as a source of potential uncertainty for equity investors in 2024.

We believe quality companies are well-suited for an uncertain environment, thanks to their moderate leverage (and lower exposure to higher rates) and higher profitability (a welcome cushion in a potential downturn). Simply put, quality matters in our view—especially now. Thus, when we look to those areas that have lagged, like domestic small caps, we continue to do so through a quality lens.

Leaders & Laggards of 2023

Source: Bloomberg, as of December 31, 2023. U.S. Large Cap is represented by S&P 500 Index, U.S. Small Cap is represented by Russell 2000 Index, DM Non-U.S. Equities is represented by MSCI EAFE Index, EM Equities is represented by MSCI Emerging Markets Index, Large Cap Growth is represented by Russell 1000 Growth Index, Large Cap Value is represented by Russell 1000 Value Index, Tech is represented by S&P 500 Information Technology Index, Comm Svcs is represented by S&P 500 Communication Services Index, Cons. Disc is represented by S&P 500 Consumer Discretionary Index, Industrials is represented by S&P 500 Industrials Index, Materials is represented by S&P 500 Materials Index, Real Estate is represented by S&P 500 Real Estate Index, Financials is represented by S&P 500 Financials Index, Health Care is represented by S&P 500 Health Care Index, Cons. Staples is represented by S&P 500 Consumer Staples Index, Energy is represented by S&P 500 Energy Index, Utilities is represented by S&P 500 Utilities Index. Commodities is represented by Bloomberg Commodities Index, Commodities ex Energy is represented by Bloomberg ExEnergy Subindex, Energy Commodities is represented by Bloomberg Energy Subindex

As a reminder, we believe the start of a new year is a prudent time to review your long-term asset allocation (the mix of stocks, bonds and alternatives in your portfolio) to see if there are opportunities for portfolio rebalancing or as part of a general reassessment of your investment goals and objectives. Some questions to consider include:

• Do I have any short- to medium-term liquidity needs?
• What is my risk tolerance? Has it changed at all after experiencing market volatility and/or any change in life circumstances?
• Have the strong returns in 2023 caused any misalignment to my asset allocation? Do I have enough equity or fixed income exposure?
• Are there opportunities to make investments that are more in line with my goals?

Portfolio Implications

Equities moved notably higher in December, led by domestic small caps. We maintain an overall neutral view across equities, while upgrading small caps, a laggard that has priced in a hard-landing scenario. Given ongoing economic uncertainty, we believe that clients may want to consider adhering to long-term strategic asset allocations. Within equities, we still favor lower-beta, higher-quality names, with a neutral view on value versus growth. In this more challenging environment, we also favor looking to active management to select companies with high earnings visibility.

Fixed income had a strong month, with longer-maturity bonds leading the charge given the movement in yields. We continue to favor credit markets, maintaining an overweight view on investment grade securities. With short-term rates set to decline substantially, we believe that clients may want to consider moving away from overweight cash positions and locking in incrementally longer-term bond yields. We maintain a neutral view on high yield debt to balance risk in portfolios as well as in view of recent spread-tightening that has reduced the risk-adjusted return potential of the asset class. We are neutral on emerging markets debt due to overall global growth fears, particularly in China.

Within private markets, in a challenged fundraising, exit and financing environment, significant opportunities exist for firms and strategies that may act as liquidity and solutions providers to help close the capital supply/demand gap and support value-added transactions. This backdrop, along with Neuberger Berman’s deep relationships and unique position within the private equity ecosystem, has translated into record levels of deal flow across our platform. We continue to see potentially compelling opportunities across secondaries, co-investments, private credit and capital solutions.

Index Returns

Source: Bloomberg, total returns as of December31, 2023. S&P 500 Index is represented by S&P 500 Total Return Index. Nasdaq Composite NASDAQ-Composite Total Return Index. Dow Jones is represented by Dow Jones Industrial Average TR. Large Cap is represented by Russell 1000 Total Return Index. Mid Cap is represented by Russell Midcap Index Total Return. Small Cap is represented by Russell 2000 Total Return Index. All Cap is represented by Russell 3000 Total Return Index. Large Cap Growth is represented by Russell 1000 Growth Total Return. Large Cap Value is represented by Russell 1000 Value Index Total Return. Small Cap Growth is represented by Russell 2000 Growth Total Return. Small Cap Value is represented by Russell 2000 Value Total Return. ACWI is represented by MSCI ACWI Net Total Return USD Index. ACWI ex US is represented by MSCI ACWI ex USA Net Total Return USD Index. DM Non-U.S. Equities is represented by MSCI Daily TR Gross EAFE USD. EM Equities is represented by MSCI Daily TR Gross EM USD. Cash is represented by ICE BofA US 3-Month Treasury Bill Index. U.S. Aggregate is represented by Bloomberg US Agg Total Return Value Unhedged USD. Munis is represented by Bloomberg Municipal Bond Index Total Return Index Value Unhedged USD. Munis Short Duration is represented by Bloomberg Municipal Bond: Muni Short (1-5) Total Return Unhedged USD. Munis Intermediate Duration is represented by Bloomberg Municipal Bond: Muni Intermediate (5-10) TR Unhedged USD. Investment Grade is represented by Bloomberg US Corporate Total Return Value Unhedged USD. High Yield is represented by Bloomberg US High Yield BB/B 2% Issuer Cap Total Return Index Value Unhedged USD. Short Duration is represented by Bloomberg US Agg 1-3 Year Total Return Value Unhedged USD. Long Duration is represented by Bloomberg US Agg 10+ Year Total Return Value Unhedged USD. Global Aggregate is represented by Bloomberg Global-Aggregate Total Return Index Value Unhedged USD. EMD Corporates is represented by J.P. Morgan Corporate EMBI Diversified Composite Index Level. EMD Sovereigns – USD is represented by J.P. Morgan EMBI Global Diversified Composite. Commodities is represented by Bloomberg Commodity Index Total Return. Commodities ex Energy is represented by Bloomberg ExEnergy Subindex Total Return. U.S. 10-Year Yield is represented by US Generic Govt 10 Yr.