Stocks Defied All Odds in 2023 to Close Near Record Highs

The proverbial wall of worry that the stock market is said to climb seemed almost insurmountable at the beginning of 2023, yet the Dow Jones Industrial Average and S&P 500 Index finished the year near record highs.

The Dow rose nearly 14% over the year while the broader S&P 500 ended 2023 with a 12-month gain of more than 24%. The tech-heavy Nasdaq Composite delivered its best year since 2003 with a whopping 43% gain.

Throughout the year, innovations in artificial intelligence helped push the market higher — even in the face of inflation fears and interest rate hikes. But those gains centered around just seven stocks — "The Magnificent Seven" — that all posted outsized gains.

The biggest winner was Nvidia, up 239%, followed by Meta platforms, up 194%. Rounding out the list was Tesla with a 102% gain; Amazon, up 81%; Alphabet, up 58%; Microsoft, 57%; and Apple up 48%.

Market strategists note that as the year progressed, the rally began to broaden to other stocks. The small-cap Russell 200 Index finished the year with a 15% gain after posting its best quarter since 2020.

Stock Winners and Losers

With AI in the air, the information technology sector proved the best performer of the S&P 500 with a 57% gain. Then came communication services, up nearly 55% and consumer discretionary, up more than 42%.

The worst performing sectors were utilities, down more than 10%; energy, down nearly 5% on declining oil prices; and consumer staples, down 2.3%.

The best-performing stocks of the year were not part of the S&P 500. MarketWatch surveyed companies valued at more than $1 billion and found the top performers were Soleno Therapeutics, up 1,900% following postive results for one of its drugs, and Carvana, up 1,050%, as the online used car dealer staged a turnaround and overcame a cash crisis.

More than 170 stocks in the S&P 500 were down for the year. Enphase Energy, a home energy solutions provider, proved the biggest loser with a more than 50% plunge, followed by agricultural science giant FMC Corp., down more than 49%.

Other big losers for the year included Dollar General, Pfizer, Estee Lauder, Etsy, Hormel Foods, Walgreens Boots Alliance and Conagra Brands.

Post-Pandemic Bear Market

Most market strategists didn't see the overall bull market coming, fretting inflation, interest rate hikes and the probality of a recession every step of the way.

On the first trading day of 2023, investors were patching holes in their portfolios. A post-pandemic bear market had dominated most of 2022. And though it ended in October of last year, the S&P finished 2022 with an 18% loss.

Inflation had peaked at 9.1% in June 2022, but it was still running high and souring consumers' moods. Most economists predicted a recession for 2023. Many market strategists were expecting a sluggish year, including Morgan Stanley's Chief Equity Strategist Mike Wilson, who was forecasting a corporate earning recession.

“The headwinds significantly outweigh the tailwinds and we believe risks for a major correction have rarely been higher,” he wrote in June.

The Federal Reserve's key interest rate, which began 2022 at effectively zero, was on the rise and would finish this year at a 22-year high of 5.25% to 5.5%. The move rattled consumers who were already struggling with high inflation, raising the costs of mortgages, car loans and credit cards.

The Fed's moves also helped spawn a handful of regional bank failures in March, including Silicon Valley Bank, the nation's second-largest bank failure after Washington Mutual Bank was swept under in the 2008 financial crisis.

All the while, Russia's invasion of Ukraine raged into its second year, threatening deliveries of grain, oil and natural gas. In September, oil prices spiked near $100 a barrel from about $70 in March. The surge threatened to keep inflation sticky and the Fed possibly poised for another rate hike.

In September, Republican lawmakers were threatening a government shutdown in a battle over the nation's burgeoning national debt. The ongoing dysfunction lead Fitch Ratings to downgrade the nation's credit rating.

In late October, the S&P was in a correction, down more than 10% from its previous high on July 31. The key reason for the dive was a spike in Treasury yields to more than 5%, a 16-year high.

Higher Treasury yields incentivized investors to move money from stocks to bonds and even to money market funds that were paying more than 5% interest.

Over the Top

It was a lot to overcome.

"2023 will be remembered for the recession that never happened," Peter Essele, senior vice president of investment management and research at Commonwealth Financial Network in Waltham, Mass., wrote in a 2024 market outlook report.

For all the worries about the economy, the nation's gross domestic product continued to grow at a healthy clip, including a 4.9% surge in the third quarter.

The labor market also proved unexpectedly resilient with the unemployment rate coming in at 3.7% in November, marking the longest run under 4% since the 1960s.

Consumer spending, which drives about two-thirds of the U.S. economy, has also held stronger than expected throughout the year, though it has shown some recent signs of softening.

Inflation ticked lower with almost every reading of the consumer price index and the personal consumption expenditures index. The CPI was at 3.1% in November. PCE came in at 2.6%.

Santa Claus Rally

With inflation falling closer to the Fed's 2% target, Wall Street is almost unanimously convinced it is done raising rates, and widely confident the central bank will begin to cut rates as early as next month.

As a result, the yield on the 10-year Treasury, a key benchmark for financial markets and consumer loans, dipped below 4%, and a Santa Claus rally ensued that took the Dow to near highs.

Traders are now betting on about an 87% chance the Fed will cut rates in March and about a 15% chance it will cut rates when it meets Jan. 30-31, according to the CME FedWatch Tool, which is based on Fed funds futures trading.

On the prospect of falling interest rates, the rally now appears to be expanding to other stocks, analysts say.