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Fidelity® Wealth Services

Fourth Quarter 2023 Review

Portfolio Advisory Services account: Defensive Approach
BY BRIAN ENYEART, CFA,* PRESIDENT, STRATEGIC ADVISERS LLC

Investment Objective

A defensive approach to investing:

  • Seeks to deliver less significant losses during down-markets in exchange for limited gains in up-markets compared to a total return approach.


Key takeaways

  • Market Backdrop: Stocks and bonds delivered healthy gains for both the quarter and the year.1 Investors appeared less concerned about inflation or the risks of a deep recession.
  • Positioning: In Q4, we shifted holdings within bonds into more diversified, longer-dated bond types to take advantage of higher rates.
  • Performance: Stocks and bonds gained significantly during the quarter and finished the year meaningfully higher. Defensive portfolio returns were positive and delivered lower volatility compared to the broad markets.
  • Outlook: We do not believe a recession is imminent. The decline in inflation has been welcome and consumer sentiment finished the year on an upward trend.



Market Backdrop

Falling inflation, resilient consumers, and stabilizing corporate profits supported economic growth.

  • Global economies felt a boost from easing inflation and strong job markets, as well as healthy global trade and tourism.
  • The U.S. Federal Reserve (Fed) signaled it’s likely finished raising rates. It may even cut rates as soon as early this year should inflation continue to ease.

U.S. stocks were up more than 25%2 in 2023 led by growth3 and technology stocks.4 Interest rates fell, giving investors a more positive long-term outlook for growth stocks. Technology stocks benefited from enthusiasm for emerging technologies.

Overseas, high levels of local government debt and an overdeveloped real estate market led to uneven growth in China. This unevenness weighed on global market economies with strong trading partnerships with China. For example, Europe’s materials sector likely faltered in reaction to China’s slowing demand for commodities. Should developments in China improve, it could bolster the outlook for many other economies.

Developed international markets outpaced emerging markets for the quarter and year.5 Europe and Japan led the way.6 Surprisingly resilient earnings growth in 2023 drove Europe’s strong performance. Additionally, Europe’s earnings growth outlook for 2024 improved, despite the conflict in Ukraine. Even though European manufacturing lagged, some sectors prospered. Europe’s top performing sector for the year was information technology,7 which benefited from recent interest in developing artificial intelligence technology. In Japan, corporate governance reforms helped corporate profits. Japan also had lower interest rates relative to the rest of the world.

Emerging markets experienced volatility during the year, mainly due to China’s uneven growth. Latin America had the strongest performance. It was aided by Brazil, where falling inflation and lower interest rates helped support growth.8

Bonds posted strong gains in the fourth quarter with high-yield bonds9 outpacing investment-grade bonds.10 Investors grew more confident about the outlook for corporate profits. Rising profits can reduce the risk of default. As a result, corporate bonds were the strongest performing investment-grade bonds.11



Positioning

Shifted within high quality bonds and broad-market stocks.

  • We broadened the holdings of high-quality bonds to take advantage of higher interest rates.
  • We slightly expanded the mix of broad-market stocks by increasing smaller-sized company stocks due to compelling valuations relative to larger-sized company stocks.

To protect against stock market volatility, we currently maintain a higher allocation to bonds compared to your long-term target asset allocation mix. We favor high quality, intermediate-term U.S. Treasury bonds along with U.S. Treasury Inflation Protected Securities to provide income and stability. With the uptick in rates offered across the bond market in 2023, we increased allocations to longer-term bonds and other high-quality bonds such as corporates, mortgage-backed, and securitized. We believe diversified bond holdings help position client portfolios to withstand periods of elevated stock market volatility.

Within stocks, we continue to focus on conservative stocks such as low volatility and quality, since they have generally experienced more price stability than broad-market stocks during volatile periods. We slightly increased exposure to smaller-sized company stocks given their historically low valuations compared to larger-sized company stocks.

We maintained positions in alternative investment strategies. These strategies remain an important part of your portfolio as they seek to reduce volatility and have shown different return patterns than broad market stocks and bonds. In addition to high-quality bonds and short-term investments, alternatives have historically provided stability during periods of stock market volatility.

As a reminder, your Defensive investment approach account seeks to temper downside risk in an effort to provide a smoother investment experience over the long term.



Performance

Declining interest rates supported global stock and high-quality bond performance.

  • Portfolio returns gained significantly during the quarter.
  • Broad market stocks posted strong gains, outpacing more conservative, low volatility and high dividend paying stocks, which still generated meaningfully positive returns.12
  • High-quality bonds rose, driven mainly by corporates and mortgage-backed.
  • Defensive portfolios tempered overall market volatility primarily due to the lower allocation to stocks compared to the long-term target mix.



Outlook

A healthy jobs market, positive wage growth, and easing inflation may continue to help consumer spending and the economy.

  • Growth may continue but moderate due to expensive borrowing costs at higher interest rates. This could result in fewer purchases for large items like homes and cars.
  • We do not believe recession is imminent.

Recent inflation readings have fallen to levels more typical for the U.S. economy. This likely contributed to the Fed’s decision to end its campaign of interest rate hikes. Consumer sentiment ended the year rising to some of its highest readings for 2023. Since consumer spending is a key driver of U.S. economic growth, this could prove supportive into 2024.

However, the U.S. economy also faces challenges. Manufacturing activity is in decline. Fewer job openings indicate shifts in the job market, even though unemployment remains low.

While we do not believe a recession is imminent, economic uncertainty may lead to bouts of market volatility. These are not unusual during late cycle expansions. That’s why we have positioned client accounts slightly below the long-term target allocation for stocks. We believe this can allow clients to participate in market rallies and potentially experience less volatility during periods of market stress. If needed, we are prepared to adjust risk exposures in client accounts if the economy begins to show signs of stalling.



Tax-Smart Accounts:

  • Market volatility during the year provided opportunities to create tax assets through tax-loss harvesting. These harvested losses may generate tax savings for some investors. Tax savings can be invested, giving them a chance to grow over the long term.
  • Municipal bonds outpaced other investment-grade bonds, returning 7.9% and 6.4% for the quarter and year, respectively.13 Healthy state and local budgets, low issuance, and strong demand supported municipal bond returns. Issuance remained low due to higher rates during parts of the year, while demand stayed strong from investors seeking tax-exempt investment opportunities.