Reflecting on 2023: 7 Key Investing Lessons

As we bid farewell to another eventful year in the world of investments, it's crucial to acknowledge that in the realm of finance, surprises are the norm rather than the exception. Expecting the unexpected has become a mantra for seasoned investors.

At the outset of 2023, we faced bank collapses, concerns of an impending economic downturn, and persistently high inflation rates. However, as the year unfolded, we witnessed a significant transformation in the investment landscape. Inflation rates moderated, the Dow 30 index reached new all-time highs, and optimism among investors grew, with the anticipation of potential interest rate cuts.

Amid these twists and turns, several invaluable lessons emerged, offering guidance for investors in 2024 and beyond. In this edition of Market Insights, we explore seven of these essential lessons.

Lesson 1: Quality Prevails During Uncertainty

Despite the ongoing uncertainty in 2023, the market continued its recovery. Notably, investors who adhered to high-quality stocks reaped rewards, outperforming those who pursued seemingly undervalued or lagging stocks.

The performance of the S&P 500 index was notably influenced by the 'Magnificent 7,' a group of stocks that accounted for nearly 30% of the index's performance. Yet, various indices tracking stocks with robust earnings quality outperformed the broader index.

The lesson here is clear: if you can withstand some market volatility, sticking with high-quality investments is often more rewarding than switching to defensive stocks. Volatility is the price of admission to potentially superior long-term returns, as noted by financial writer Morgan Housel. Timing the market perfectly on two trades can be challenging, and the age-old adage, "time in the market beats timing the market," consistently holds true. Investing in high-quality stocks that you understand and believe in is generally less stressful and more rewarding.

Additionally, maintaining a watchlist of companies you'd like to own and tracking their qualitative aspects can be highly beneficial in seizing opportunities when their stock prices align with your expectations.

Lesson 2: Disregard Predictions

Every year, financial media inundates us with S&P 500 price predictions from Wall Street strategists for the following year. These predictions often span a wide range, and the actual market performance rarely aligns with these forecasts. Predicting market movements is a challenging endeavor, often clouded by recency bias.

Furthermore, historical data shows that annual returns seldom mirror the average. The S&P 500's average return since 1957 slightly exceeds 10%, yet it has rarely fallen within 5% of that figure over the past six decades.

Lesson 3: Markets Anticipate the Future

While market predictions can be unreliable, financial markets themselves are adept at discounting future events. The S&P 500 index, for instance, began declining nine months before earnings started falling, subsequently hitting its bottom about nine months before earnings growth turned positive once more. This occurred despite widespread predictions and discussions of an impending recession.

Market participants should remember that earnings reflect the recent past, whereas financial markets are forward-looking. Opportunities often emerge when markets react to past events, and stocks are valued attractively. This underscores the importance of ignoring market noise and maintaining a long-term perspective.

Lesson 4: The Road to Success Can Be Bumpy for New Industries

The rapid growth of the global electric vehicle (EV) industry in 2023 faced challenges as it transitioned into the mainstream. High EV prices posed a barrier for many consumers, necessitating cost reductions through economies of scale.

Such challenges are not unique to the EV industry; growing sectors can encounter obstacles even amid positive cash flows. These hurdles, however, create opportunities for patient investors.

Narrative investing allows investors to determine the right price for a share and exercise patience. Developing narratives for promising companies and adjusting them as needed provides a strategic advantage. If you feel you've missed out on burgeoning industries like artificial intelligence, remember that opportunities often reappear. Creating narratives for top companies ensures you're prepared when these opportunities arise.

S&P500 Index - 2023

Lesson 5: High-Yield Stocks Require Close Scrutiny

October served as a stark reminder of the risks associated with some dividend stocks, particularly those with enticing yields. As bond yields increased, real estate and utility stocks, known for their high dividend yields and substantial debt usage, experienced a sudden decline.

Investors should assess the debt levels and sustainability of dividend payments of the companies they invest in. Checking a company's financial health and dividend payments, alongside evaluating its growth prospects, provides a comprehensive picture.

Lesson 6: Avoid Over-Concentration

The collapse of Silicon Valley Bank in March 2023 highlighted the risks of over-concentration. The bank primarily served technology companies and their employees in California. When the tech sector faced challenges, companies and employees began withdrawing deposits, triggering a run on the bank. Even if the bank hadn't collapsed, its reliance on a specific market would have severely hindered its business.

Similar vulnerabilities can affect companies relying on a single product, market, or a limited group of customers. While investing in such companies isn't necessarily discouraged, investors should consider these risks when determining position sizes and valuations.

Lesson 7: Great Companies Evolve Continuously

The exceptional performance of companies like Microsoft, Alphabet, Nvidia, and others in 2023 underscores the wisdom of Warren Buffett and Charlie Munger: "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."

These companies, which benefited from the growth of the AI industry, continually reinvented themselves. Initially founded without AI in mind, they demonstrated how strong leadership, a vibrant corporate culture, intellectual property, and robust cash flows enable continuous innovation and expansion.

Investing in such companies at reasonable valuations allows narratives to evolve far beyond initial expectations. These are the companies to hold onto as long as they keep innovating, contributing to long-term success in the world of investments.

As we conclude this year's Market Insights, we extend our warmest wishes for a joyful holiday season and a prosperous new year. May your investments in 2024 be guided by these valuable lessons, leading you toward financial success.

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