U.S. equity markets ended 2023 on a high note in December with a year-end rally that led major U.S. stock indexes to their ninth positive week in a row. The S&P 500 gained 4.5% in December and closed out the year up 26.3%, just short of setting a new all-time high. The Federal Reserve helped fuel much of this upward move with a dovish policy pivot during their last meeting of the year. At the December 13th meeting, Fed Chair Jerome Powell communicated that the tightening cycle was complete and, furthermore, indicated that the start of a rate-cutting cycle would begin in 2024, sending stocks on a tear to end the year.
The Morningstar Wide Moat Focus Index (MOAT, the “Moat Index”) surged by 7.87% in December outpacing the S&P 500 by over 300 basis points during the month, and ended the 2023 calendar year up 32.41%, or 600 basis points above the S&P 500. The performance of the Moat Index is particularly notable this year, as it came amid a top-heavy market where the mega-cap Magnificent Seven was responsible for much of the market’s overall gains. Illustrating this is the S&P 500 Equal Weighted Index which only gained about 14% in 2023. The Moat Index outperformed despite this challenging environment for equal-weighted strategies, bearing testament to the moat investing philosophy and the rigorous Morningstar equity research that underpins the index.
Small- and mid-caps were beneficiaries of market breadth expansion in December, leading to a continuation of their rebound that began in November and outperformance relative to large-caps in the final month of the year. The Morningstar US Small-Mid Cap Moat Focus Index (the “SMID Moat Index”) returned 9.72% in December, outpacing the broad mid-cap benchmark but lagging pure small caps. However, for the full year, the SMID Moat Index gained 17.93%, outperforming both pure small- and mid-cap benchmarks by over 100 basis points.
U.S. Equities Finish the Year Strong | As of 12/31/2023
|Source: Morningstar. As of 12/31/2023. Past performance is no guarantee of future results. Index performance is not representative of fund performance. It is not possible to invest directly in an index. Fund performance current to the most recent month end is available by visiting vaneck.com or by calling 800.826.2333.
Positioning Heading into 2024
Both the Moat and SMID Moat Indexes underwent quarterly reviews on December 15, 2023. Each quarter they systematically target the most attractively priced, high quality U.S. companies within their respective universes. Below are a few takeaways from the reviews and how the indexes are positioned to start the new year. Full results of the most recent quarterly reviews are available here: Moat Index and SMID Moat Index.
Moat Index Review Highlights
Growth and Technology Remain Underweights
The Moat Index saw its technology exposure increase to the largest overweight in quite some time at the beginning of 2023, following the extreme declines in valuations for the sector in 2022. However, throughout 2023, the Index migrated away from growthy tech and toward value stocks as shares prices of tech names rebounded. This trend continued at the December review with the index shifting further from tech and growth. Exposure to more defensive sectors such as health care, consumer staples and industrials all increased this quarter, while technology now sits at a 13% underweight relative to the S&P 500.
Opportunity Drives Smaller Cap Tilt
The equal weighting methodology of the Moat Index introduces a structural bias away from mega cap companies relative to the market-cap weighted benchmarks like the S&P 500. However, throughout 2023 the Moat Index has tilted more toward smaller sized moat companies then is typically the case. Attractive valuations of smaller companies that have lagged much of the year is a primary force behind this shift. The Index’s market-cap size profile is about as small as it has been in the last ten years now, however in aggregate it still remains within the large-cap segment.
The weighted average price-to-fair value of the Moat Index fell from 0.85 to 0.83 following the December review, signaling a 17% discount to Morningstar’s fair value estimate. This is in contrast to the price/fair value ratio of the S&P 500 Index which currently sits at 1.0, implying that the companies in the S&P 500 are, overall, fairly valued according to Morningstar.
SMID Moat Index Highlights
Consumer Discretionary and Auto Industry Retain Overweight’s
This quarterly review the SMID Moat Index saw the removal of several specialty retailers, including Williams-Sonoma (WSM) and Burlington Stores (BURL). Despite these removals, the consumer discretionary sector remains the largest overweight within the index. Automobile dealers and suppliers, a top contributing industry in 2023, account for the largest portion of this discretionary exposure with a roughly 9% weighting. At the December review, additional auto industry names were added indicating that there is still opportunity within that segment of the market. Companies added include Lithia Motors (LAD), CarMax (KMX), AutoNation (AN), and Lear Corp (LEA).
Mid Cap Remains Largest Exposure; However Small Caps Saw an Increase
Companies with a moat are typically larger, more-established entities, leading to a general skew towards mid caps within the SMID Moat Index relative to broad SMID benchmarks like the Russell 2500 Index. However, the December quarterly review saw a slight shift, about 3% in weight, from mid caps to small caps. Small-cap exposure increased to roughly 1/3rd within the Index while mid-cap accounts for the remaining 2/3rds. Attractive valuations within the smallest cohort of the eligible universe are a primary factor for this shift.
Core and Value Remain Primary Style Exposures
Style exposure within the SMID Moat Index moved slightly toward value this quarter with the shift coming entirely at the expense of core. Core and value both remain the primary style exposures, while the change in growth was negligible with the style representing a notable underweight relative to the Russel 2500 Index.
|Index Style Exposure
|Relative to Russell 2500 Index
|Source: Morningstar. As of 12/15/2023. Index performance is not representative of fund performance. It is not possible to invest directly in an index.
Valuation Opportunity within SMID Moats
The weighted average price-to-fair value of the SMID Moat Index fell to 0.81 following the December review, signaling a 19% discount to Morningstar’s fair value estimate. The broad-based Russell 2500 Index, featured a weighted average price-to-fair value ratio of 1.00 as of the same date.
Accessing Moat Stocks
Source for all data unless otherwise noted: Morningstar.
Fair value estimate: the Morningstar analyst’s estimate of what a stock is worth. Price/Fair Value: ratio of a stock’s trading price to its fair value estimate.
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