Thank You, Sir – May I Have Another?

Equity investors received an unexpected gift of broad market returns during the fourth quarter, capping a year in which global equity performance exceeded expectations.

For the quarter, U.S. equities, as measured by the Russell 3000 Index, advanced 12.1%. Growth continued its dominance garnering 14.1% versus 9.8% for Value. Surprising most investors, small caps outpaced large caps, rising 14.0% versus 12.0%. Within the small cap environment, Value outperformed Growth 15.3% versus 12.8%. For large caps, Growth extended its leadership outpacing Value 14.2% versus 9.5%.

Outside the U.S., the performance of broad market indexes was meaningful, yet lagged that of the U.S. The MSCI All-Country World Index ex-USA (ACWI x-USA) rose 9.8%, driven by developed markets which advanced 10.5%. Emerging markets increased 7.9%.

For the year, U.S. equities outpaced foreign equities, rising a resounding 26.0% versus 15.6%. U.S. large caps increased 26.5%, attributed to the parabolic return of 42.7% ascribed to Growth. While Value was also positive, its return of 11.5% appeared modest relative to that of Growth. The strong finish by U.S. small caps lifted this asset class 16.9% year-over-year (YOY).

Foreign developed markets outperformed emerging markets, rising 17.9% versus 9.8%. Unlike the U.S., within the framework of ACWI x-USA, Value outperformed Growth 17.3% versus 14.0%.

Tailwinds – To Be Continued?

As the fourth quarter progressed, positive sentiment drove overall expectations which expanded valuations. A “risk-on” mentality emerged as investors believed the Fed would conjure a soft-landing. Comments after December’s Federal Open Market Committee meeting indicated a potential pivot to interest rate cuts during 2024. FOMO, or the Fear Of Missing Out, fueled a herd mentality expanding valuations through the end of 2023. Additionally, the optimism attributed to upward earnings revisions by analysts of forward estimates lent credence to investor sentiment.

According to the London Stock Exchange Group, analysts estimate earnings for U.S. large cap companies grew 5.2% YOY during the fourth quarter, materially below their initial estimate of 11.0% YOY at the beginning of the quarter. Regarding U.S. small cap companies, earnings are expected to contract 10.4% YOY versus an initial estimate of 4.6% YOY growth at the beginning of the quarter.

For the first quarter of 2024, analysts project earnings growth of 7.4% YOY for U.S. large cap companies. For U.S. small cap companies, analysts estimate earnings growth of 13.0% YOY.

While analysts estimate earnings of companies domiciled outside the U.S. to increase, the estimated YOY growth rate is anticipated to be less than that of their U.S. peers.

Valuations for U.S. companies may appear frothy as the price-to-earnings ratio for the trailing 12-months (P/E TTM) which stands at 22.1x, is materially above its 20-year historical average of 17.5x. Looking forward, this same measure for the next 12-months (P/E NTM) appears elevated at 18.9x, above its historical average of 15.6x. One may question; does valuation present a headwind to future performance in U.S. equities?

Reference our 2024 Economic Themes (Scan the QR code at the bottom of the page to view), in which we analyzed valuations and subsequent 12-month returns in U.S. equities. Our analysis noted, “When considering valuations greater than 18.1x, 303 (or 50.6%) of the total observations fall into this range of which 234 exhibited positive returns in the subsequent 12-months, averaging 16.2% with a median return of 11.4%.” We’re not suggesting that 2024 will result in double-digit positive returns solely based on valuations, multiple expansion and historical patterns. Given analyst estimates for forward earnings, coupled with the anticipated macro-environment, equities warrant continued consideration.

Let’s Be Careful Out There

While sentiment may explain near[1]term moves, investing requires a proven process. We believe our process which emphasizes quality factors such as sustainable revenue and earnings growth, various return metrics (e.g., return on equity, return on invested capital, and return on assets), and relative valuation succeeds over time. When combined, these culminate in a backdrop to effectively manage risk and capture relative return within equities.

The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.

This content is provided for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and should not be interpreted as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.