How Equity Factors Fared in 2023

2023 is wrapping up, and by now the equity landscape has come into full focus. To better explain a year that experienced a highly influential Federal Reserve (Fed), geopolitical tensions, and a regional banking crisis, we decided to explore equity style factors. Style factors can be extremely useful tools by assigning attributes such as size, value, and volatility to stocks to paint a picture of how investing themes have developed. Today, we examine the performance of various style factors this year, compare them with last year, and speculate on what could be in store for 2024.  

What Worked…

Growth: We’d be remiss if we didn’t start by highlighting the strength of growth-style investing this year. Within the Russell 3000 Index, an equal-weighted basket of the top quintile of growth stocks has outperformed the bottom quintile by over 19% through December 19, 2023. While this might not come as a huge surprise to some, it’s important to note the equal-weighted nature of this metric, which is a divergence from the typical readings one would note on a market-capitalization-weighted index such as the S&P 500. 590 different stocks are pari-passu in that top quintile, not simply a weighty amalgamation of the “magnificent seven.”

Value: Investors who concentrated on higher value-style companies would have experienced better returns if they equally weighted the entire index. The top 20% of value-focused stocks — that is, stocks with low prices relative to their fundamental value — outperformed the bottom 20% by 13.7% year-to-date (YTD) through December 19.

The table below highlights the difference in returns between equal-weighted top and bottom quintiles for some of the best-performing factors within the Russell 3000 Index. 

2023 Top-Performing Russell 3000 Factors

Source: LPL Financial, Bloomberg 12/19/23

Market Cap: A focus on larger market-cap stocks within the Russell 3000 Index would have done well for investors throughout much of the year. However, we’ve recently observed a rotation with smaller companies taking the lead after the Fed signaled a pivot in policy following the October/November meeting. As interest rates turned lower, small caps outperformed as they tended to be more reliant on debt issuance to fund operations. The chart below highlights the path of this rotation using the difference in returns of the top equal-weighted quintile of market cap-weighted stocks minus the bottom quintile.  

Russell 3000 Small Caps Surge Back Post Fed Meeting

Source: LPL Financial, Bloomberg 12/20/23
Disclosures: Indexes are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results.

…and What Didn’t

Low Volatility: Lower-volatility stocks lagged their higher-volatility counterparts as much of the low-volatility sectors, like utilities and consumer staples, underperformed the higher-volatility sectors such as technology and communication services. Again, investors skirted typical yield-heavy utilities for better risk-adjusted fixed income; and defensive-oriented staples for more risk-on growth names. The table below illustrates how lower-volatility sectors generally lagged more volatile sectors in 2023.  

Russell 3000 Sectors

Source: LPL Financial, Bloomberg 12/19/23

High Dividend Yields: Unfortunately, those who experienced the relative boon from high-dividend-paying stocks in 2022 didn’t have the same success this year. As interest rates on money market funds and debt instruments accelerated, the income streams provided by equities became a lot less attractive. The 1.5% trailing twelve-month dividend yield on the Russell 3000 has been eclipsed by higher yields and better risk-adjusted returns on fixed income securities.

The chart below highlights the relative strength the top quintile dividend-yielding, and low-volatility stocks had over the bottom quintiles during 2022, and their subsequent stalled performance YTD (through December 19). 

High Dividend Yield and Low Volatility Stocks Cool Off

Source: LPL Financial, Bloomberg 12/20/23
Disclosures: Indexes are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results.

Looking Ahead

As we think about 2024, we expect inflation to cool further and interest rate stability to become normal again. This should provide upside potential in earnings for growth stocks, particularly in the technology and communication services sectors. Quality-style stocks may underperform until concerns about stalling economic growth make their way into the market. That could mean the small cap rally we’ve seen in the past two months may continue in the very short term but will likely stall over the next 2–3 months as the economic environment potentially becomes more difficult.