2023: Assessing the Remarkable U.S. Equity Performance – Impressive or an Outlier?

Introduction

As we approach the final months of 2023, it’s an opportune moment to reflect on the remarkable performance of U.S. equity indexes thus far. The year has been characterized by substantial gains, with the Nasdaq-100 Index (NDX) leading the pack, posting an impressive year-to-date (YTD) increase of nearly 43%. The S&P 500, Russell 2000, and Dow Jones Industrial Average have also shown robust gains of 18%, 8.72%, and 4.79%, respectively. However, before we declare 2023 as an outlier, let’s take a closer look at the factors driving this performance and put it into historical context.

The “Magnificent Seven” and the AI Theme

The notable success of U.S. equity indexes can be largely attributed to a select group of heavyweight companies often referred to as the “Magnificent Seven.” These companies, including Apple (AAPL), Microsoft (MSFT), Alphabet (GOOG), Amazon (AMZN), NVIDIA (NVDA), Tesla (TSLA), and Meta Platforms (META), have played a pivotal role in propelling the markets forward. The overarching theme driving their performance is the anticipated impact of artificial intelligence (AI) on various industries.

Comparing NDX and SPX Holdings

To understand the dynamics at play, let’s conduct a side-by-side comparison of the top 10 holdings in the Nasdaq-100 Index (NDX) and the S&P 500 (SPX), including their relative weights in each index. Notably, these indexes share significant overlap in their “primary ingredients,” with this year’s top performers prominently featured. The difference in performance can be attributed to the higher weighting of these tech giants in the NDX and the drag created by financial and energy sectors on the SPX.

Historical Context: Is 2023 an Outlier?

To determine whether the performance of 2023 is an outlier, we must examine historical data. Surprisingly, this would mark the ninth time since 1985 that the NDX gained 40% or more in a year. In contrast, the SPX has never recorded such substantial gains over the same period. This observation resonates with a comment made by Kris Sidial in a February 2023 interview, highlighting the potential for asymmetric right tail payoffs in the NDX if sentiment regarding a tech recovery gained traction. Sentiment indeed shifted favorably in this direction.

However, it’s essential to maintain perspective. Over the past 38 years, the SPX has more frequently added between 20% and 39.99% annually, occurring thirteen times, while the NDX’s distribution for such gains is only six instances. An 18% gain through August places the SPX within the realm of typical performance, with the possibility of marking the eleventh year with a 10% to 19.99% gain.

Examining the Left Tail

To assess downside occurrences, we must also examine the left tail of the distribution. The NDX has experienced five instances of falling 30% or more in a year, with the most severe decline of 41.89% occurring in 2008. In comparison, the SPX registered a 37% decline during the same tumultuous year.

Impressive but Not Outliers

In summary, the year-to-date performance of U.S. equity indexes is undoubtedly impressive, particularly for the NDX. However, it does not necessarily make 2023 an outlier. Similar surges in the NDX have been witnessed in the past, particularly during the mid-90s and the late 90s when annual gains reached 85.3% and 101.95%, respectively.

Managing Potential Drawdowns

If you’re concerned about potential market drawdowns in the final months of the year, there are various Nasdaq-100 Index options (NDX, NQX, XND) available to help manage your exposure and navigate the ever-changing landscape of equity markets.

Conclusion

The performance of U.S. equity indexes in 2023 has undeniably been impressive, driven by the exceptional contributions of the “Magnificent Seven” and the transformative potential of AI. While the gains have been substantial, they are not necessarily outliers when viewed through the lens of historical data. Understanding these dynamics and being prepared for potential market fluctuations is key for investors and traders as we approach the remainder of the year.