My Opinions About 2023’s Stock Market Performance

2023 was a good year for the stock market with all major indexes up.

When the market is up, most everyone is happy, but not everyone. There are many people who try to beat the market, and what they buy drops, or they sell stock short or sell or buy put-and-call options or do other things that add risk while chasing higher returns, hoping to outsmart the other investors. So, let me set some ground rules for my clients and the people who read my blogs. My comments and suggestions are directed toward people who primarily invest to accomplish goals or who want to secure their financial future. I refer to these as my typical client. I do not advise traders or people with other goals, so those people should stop reading right here. Bye Bye.

I have advised many clients and realized quite some time ago that most people determine a method of investing for themselves, get comfortable with it, and are reluctant to switch away from it. They might come to me to either validate their thinking or perhaps do some tweaking, but my best clients are those who are not entrenched in a strategy. These are usually people who were “afraid” of the market and now want a strategy that would work for them, assuming they were not on track to achieve their goals. If they were on track, then why look to change anything?

Over the years I’ve developed some techniques that seem to work and get my points across. I define this with three words. Data, Focus, Plan.

The rest of this blog will provide an understanding of what the stock market represents and means for my typical client or the typical investor.

Owning stock means you own a share of a company. In most cases, it is a very small share, but nevertheless, it is a share of that company. Now, if you own a share in just one company, the achievement of your plan is precarious and solely depends on how well that company does. So, one of the rules of investing is to spread your risk, and you do that by owning shares in many companies. How many depends on quite a few factors, but I think it could be anywhere from 10 companies to 2000 companies. We may not agree on the number of companies, but we can agree that it should be more than 1 or 2. To provide some background, I taught an MBA corporate finance course, and it “proved” that a portfolio of equal ownership in five companies will perform the same as the group from which they were chosen within six or seven percent. As the five stocks are increased the percentage difference drops. To further add information, the Dow Jones Industrial Average (DJIA) consists of 30 stocks, while the S&P 500 Index is made up of 500 stocks, and the NASDAQ 100 comprises 100 stocks. However, the way those indexes are structured, the top 10 stocks in each index drive a disproportionate sway on the performance of those indexes. So, a suggestion if you create your own portfolio is to have pretty equal investments in at least 10 stocks.

Irrespective of how you choose your stocks, when the market goes up, most stocks will go up and when the market goes down, so will most stocks. Owning a diversified group of stocks will not insulate you from the waves of ups or downs of the market as a whole.

Usually, the best way to own stocks is to invest in a mutual fund, of which there are many including funds that try to duplicate the major indexes. However, there is always a desire to pick your own stocks and, in effect, try to do better than the market as a whole. I do not think this is a good strategy and here are 10 major companies whose shares ended 2023 lower than they were 10 years earlier: Verizon, 3M, Levi Strauss, Walgreens Boots, Bristol-Myers Squibb, Pfizer, GM, Ford, IBM and GE. Each of these lost money over a 10-year period where the DJIA was up 127%, the S&P500 was up 158% and the Nasdaq was up 259%!

Now the question is, why buy stocks, and what do you get from them? There are many reasons people justify investing in stocks, but I suggest that there should only be one overriding reason. To share in the long-term growth of the economy as it is hoped will be reflected in the value of a well-diversified stock portfolio.

The specific benefit of owning stock is comprised of the dividend payments and the increases in the stock prices. People who plan for long-term security would need both of these. Money is spent on living costs, not stock price increases. Of course, if dividends are not sufficient, then there would be periodic sales of stock, but I believe a better strategy is to have sufficient cash flow, i.e., dividends plus interest on the fixed-income part of the portfolio. If there is adequate time to plan, this could be worked out. If not, then a periodic reduction of principal is necessary, but this needs careful thought on how it will be executed. However, I am straying from my discussion about the stock market. Another consideration is inflation. With stocks, there is some possibility of increases in values and dividends to keep buying power aligned with increasing costs. With a complete fixed-income portfolio, there is almost no possibility of keeping up with increasing prices unless there are excessive funds in that fixed-income portfolio. This also is a different discussion.

Owning stocks is owning pieces of many businesses. So, let’s look at what drives stock prices. The basic starting point for this is the current and expected earnings, current and expected dividends, and the sustainability of both. This means the companies need to be profitable and remain so and be willing to distribute some of those earnings to their stockholders. Another driver of value is the multiple the “market” places on that company’s earnings and all the other companies’ earnings. This is called the Price to Earnings ratio, or PE. When there is optimism about growth the PE is higher. When growth is expected to be very slow but steady, it is lower, and when growth is not expected, it is very low. BTW the “market” is the net aggregate result of everyone buying and selling stocks at a given time or over a given period.

Expectations of the future play into the determination of the PE. For example, when a company announces it is working on a major game changer, there could be very high growth expectations and the price of its stock could shoot up substantially. It would have no PE, since it would not as yet have earnings, and the expectations would drive the price. Once the product is started to be marketed, the expectations start to be shaped by the actual sales potential, and that price could drop. Still no PE. When profits start to materialize, the expectations become more realistic as to the marketability of the product, the types of customers, the uses, the costs to market and margins, and profits. The stock’s price starts to level off, but still at a high PE level since the high price assigned to that stock will not cause widespread selling, but more likely a reduction of buying, i.e., a reduced demand. So, this highflyer now has a PE ratio and that is pretty high. Assuming it is a real company making and selling a real product, the sales will start to grow as will profits. The overall initial expectations of unlimited growth have dropped, but new expectations developed founded on how high the sales could grow along with the potential profits, and the PE would reflect this with a higher-than-market PE. At some point this high-flying product becomes normalized with sales, profits, and reduced investor excitement and the PE reverts to a market PE for that industry. This could occur in a few years or over decades depending on the company, product, profitability, growth potential, and demand for it. Also factoring into the PE are inflation, interest rates, tax policy, expectations for the economy, political factors, global affairs and dozens of other issues. It is complicated, but this is how it works. The Wall Street Journal publishes daily the PE ratios of the DJIA, S&P500 and NASDAQ indexes. You can also look up any stock on your smartphone any time you want and instantly see the PE ratio and dividend yield.

A word about the current stock market. The stock market is a financial asset and, as such, competes with every other financial asset. In six of the last 10 years, we saw short-term interest rates drop below 1% while inflation was considerably higher. This was “encouragement” for many investors to leave the short-term fixed-income market and shift to stocks that were paying dividends of around 2%, with the expectation that continuing and growing profits would push up the dividend payments. That had the effect of pushing up stock prices since the demand for stocks grew. Further, the stock market works opposite to normal buying patterns. Usually, when most prices increase, consumption seems to drop. When stock prices increase, more people seem to want to buy stocks. Crazy!!!??? But that is how it seems to be. Imagine walking into a butcher and hoping the price of meat increases just before you buy it. Well, that is how many people buy stocks. They only buy when the prices go up.

Some takeaways are that earnings and dividends drive stock prices so when investing, look for the earnings and the dividend payout. The PE ratio is a reflection of optimism, so be careful of a much higher than market PE since, at some point, it will revert to the market PE. Also, there are too many other factors affecting the prices of stocks and too much info we do not know, so if you want to invest in the stock market, consider a mutual fund or index fund.

I believe the above presents a reasonable picture of how stocks are priced, and the stock market works. Consider the above and work at securing your financial future and attaining your goals and think long-term.

COMMENT: All opinions here are mine and are intended for educational and instructional purposes and should not be considered as any sort of recommendation for any investments or any investment actions in any manner.