Decomposing 2023 equity market returns, a large part of the gains can be attributed to valuation re-rating but we see less scope for further re-rating in 2024.

1. US equity markets are increasingly concentrated

The big equity market winners of 2023 were the US mega cap tech stocks. The 'magnificent 7'1 firms drove 88% of the S&P 500’s annual price return, and at the end of 2023 made up 28% of S&P 500 Index market cap2. These firms face a high earnings bar in 2024 given 12-month forward expectations above the rest of the S&P 500 index3. The valuation of the top ten stocks in the S&P 500 also sits around 45% above that of the remaining 490 companies2.

Given these elevated earnings expectations and valuations, investors might now consider rebalancing their equity portfolios based on their investment objectives and risk appetites. 

2. Quality stocks tend to outperform in periods of turbulence

The economic outlook for 2024 remains uncertain. In 2023, inflation receded as energy and food prices eased and central banks increased policy rates. But this fall in inflation could impact currently elevated corporate margins and thus earnings. Growth has been resilient in the US, and real wage growth in Europe is a support looking forward – but still-high interest rates and (in the US) the depletion of Covid era savings could start to weigh on activity more strongly.

Geopolitical tensions might stress supply chains and impact goods prices. In such an uncertain environment, quality stocks – with strong balance sheets, good cash generation, and proven management teams – look attractive, given they tend to outperform in periods of macro turbulence.

3. Income can ballast portfolio returns

Decomposing 2023 equity market returns, a large part of the gains can be attributed to valuation re-rating. This is particularly the case in the US and Japan – the US thanks partly to hopes of AI boosting longer-run earnings potential, and Japan due to corporate governance reforms and an exit from decades of low inflation. However, valuation pick-up occurred across regions, contributing more to equity gains than rising earnings expectations or dividends in European and EM indices too. We therefore see less scope for further re-rating in 2024, which could make income a more important component of portfolio returns. Beyond equities, multi-asset investors might also be looking for alternative income sources given the recent move lower in yields and spreads.