Midyear Market Review

Dimensional Fund Advisors

The first half of 2023 gave investors plenty to process—from banking turmoil to a morphing yield curve to the debt ceiling debate. Those with diversified portfolios of equities and fixed income were in a good position to benefit from both assets’ advances at the year’s midway point, a welcome turn from last year’s broad declines.

The Big Picture

US stocks began 2023 with gains.¹ Inflation showed signs of cooling, and the Federal Reserve paused in June after a series of rate increases. Regional banks and their holdings came under increased scrutiny in early March, and several lenders were sold to larger banks as some depositors fled. Around this time, US stocks began a decline, only to resume their ascent weeks later. That rally was led by technology stocks,² whose surge coincided with increased attention on artificial intelligence and its potential.³ Value stocks and small caps started the year with gains, but growth stocks and large caps overtook them in the second quarter through mid-June.⁴ The bond market rebounded after one of its worst years in decades.⁵

Inflation continued to retreat from last year’s four-decade high, with the 12-month rise in US consumer prices falling to 4% in May.⁶ The reading a year earlier was more than double that. Fed officials paused on raising the benchmark federal funds rate in June after more than a year of increases, but signaled they were leaning toward resuming rate increases if inflation doesn’t cool further. The rapid rise in interest rates left some regional banks, such as Silicon Valley Bank, in precarious financial positions, resulting in three of the four largest bank failures on record.⁷

A Debt Diversion?

In Washington, politicians debated the US debt ceiling. After much back-and-forth, the president and Congress agreed on a deal to raise the debt limit in June, avoiding the impending possibility of a US default. Amid the discussions, stock and bond markets seemed to take the news in stride. The S&P 500⁸ was up 15.8% through June 16, bouncing back from a two-year low in October and shifting from bear-market to bull-market mode upon reaching a 20% gain from the prior trough. Historically, US equity returns following sharp downturns have, on average, been positive. A broad market index tracking data from 1926–2022 in the US⁹ shows that stocks tended to continue to deliver positive returns even after the initial recovery from a bear market, or a decline of 20% (See Exhibit 1.)

EXHIBIT 1

Chart comparing stock market returns 1, 3, and 5 years following a bear market. Source: Dimensional Fund Advisors

A Global Perspective

Among the strongest performers so far in 2023 have been technology stocks, recovering after a poor showing in 2022. The tech-heavy Nasdaq rose 30.8% through mid-June. Much of the stock market’s gain can be attributed to just a handful of companies, led by NVIDIA, which saw strong chip sales as interest in AI built.¹⁰

Global stock markets also bounced back after posting their worst year since the financial crisis. Global equities, as measured by the MSCI All Country World Index, rose 14.2% through mid-June. Developed international stocks, as represented by the MSCI World ex USA Index, added 13.0%, while emerging markets lagged, with the MSCI Emerging Markets Index up only 8.8%.

Recent history reminds us that emerging markets can be volatile, but they represent a meaningful piece of the investment opportunity set, accounting for more than 11% of the total global equity market¹¹ and providing potentially valuable diversification for an investor’s portfolio. In recent years, the returns of emerging markets have lagged those of developed markets, with emerging markets underperforming US stocks by over 10 percentage points on an annualized basis from 2012-2021 (see Exhibit 2). While recent returns have been disappointing, it is not uncommon to see periods when the reverse is true. For example, just looking back to the prior 10 years (2002–2011), emerging markets outperformed US stocks by more than 10 percentage points and other developed markets by 8 points on an annualized basis. Over the entire 20-year period (2002–2021), emerging markets posted an annualized compound return of 9.7%, matching the return of US stocks and outperforming other developed markets.

EXHIBIT 2

Source: Dimensional Fund Advisors¹²

Globally, value stocks and small caps started the year outperforming growth and large cap stocks, respectively, but underperformed across the full period.¹³ However, it’s important to keep value’s recent performance in context. Last year, value outperformed growth by the largest one-year margin since 2000. That turnaround rewarded investors who remained disciplined during the three-year slump for value that ended in June 2020. Meanwhile, large cap stocks have outpaced small caps so far in 2023. Historically, small caps and value stocks have outperformed over the long term.

Inverted Curve, Rising Yields

US Treasuries rebounded after posting their worst annual return in decades last year. For more than six months, the yield on the 10-year government bond has been lower than that of three-month bills, keeping the yield curve inverted. Despite rising bond prices generally, yields (which fall when prices rise) were higher than they have been for most of the past decade.¹⁴

Several questions appear likely to capture investors’ attention for the second half of 2023. What’s ahead for the economy in the US and elsewhere? Will the new bull market charge ahead or take a breath? How long will investor enthusiasm last for all things AI? What investors do know is that markets will continue to quickly process information as it becomes available. A long-term plan, one focused on individual goals and built on confidence in market prices, can put investors in the best place for a good experience, whatever may be in store.

Based on the S&P 500 Information Technology Index, which rose 41.6% vs. 15.8% for the S&P 500 Index.
Ari Levy, “The Tech Trade Is Back, Driven by A.I. Craze and Prospect of a Less Aggressive Fed,” CNBC, May 26, 2023.
Based on returns of MSCI All Country World Value Index, MSCI All Country World Growth Index, MSCI All Country World Small Cap Index, and MSCI All Country World Index (large caps). MSCI data © MSCI 2023, all rights reserved.
As measured by benchmark US Treasuries, which posted one of their worst annual returns in decades in 2022: The Bloomberg US Treasury 10-Year Bond Index lost 16.3%. Data provided by Bloomberg.
Inflation data as defined by the Consumer Price Index (CPI) from the US Bureau of Labor Statistics.
Matthew Goldberg, “The 7 Largest Bank Failures in US History,” Bankrate, May 1, 2023.
Fama/French Total US Market Research Index: July 1926–present: Fama/French Total US Market Research Factor + One-Month US Treasury Bills. Source: Ken French’s data library: https://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html
James Mackintosh, “Eight Megacap Stocks Make for a Funny Sort of Bull Market,” Wall Street Journal, June 7, 2023.
Emerging markets represented 11.4% by market capitalization of MSCI All Country World IMI Index as of December 31, 2022.
Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Indices have been included for comparative purposes only. In USD. US market is represented by Russell 3000 Index, developed ex-US markets represented by MSCI World ex USA IMI Index (net div.), and emerging markets represented by MSCI Emerging Markets IMI Index (net div.). MSCI index returns are net dividend. MSCI data © MSCI 2022, all rights reserved. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. All rights reserved.
“Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity, Quoted on an Investment Basis,” Federal Reserve Bank of St. Louis, June 2023

The index performance data appearing or referenced (directly or indirectly) herein has been compiled by the respective copyright holders, trademark holders, or publication/distribution right owners of each index. Historical performance results for investment indexes and/or categories are for illustrative purposes only and do not represent actual portfolio performance. The indexes and/or categories generally do not reflect the deduction of transaction and/or custodial charges, or the deduction of an investment-management fee, which would decrease historical performance results. Investors cannot invest directly in an index.

This content is developed from sources believed to be providing accurate information as of the date of publication, and is intended for informational purposes only. Please consult your financial professionals for specific information regarding your individual situation. Past performance does not guarantee future results. All investing involves risk, including risk of loss.