Many investors use the start of the year to make predictions for the upcoming year and to think about ways to express views on these themes. This undertaking is not guaranteed to add value: predicting the future is incredibly difficult and success requires correctly predicting both the drivers of future performance and the upcoming impact of different market segments. The countless possible scenarios mean that is it easy to be wrong-footed.

Nonetheless, the inherent challenge of forecasting means that investors may wish to focus their attention on market segments where there is greater reward for correct insight. Dispersion provides an initial assessment of the potential reward for such insight. The greater the dispersion, the greater the potential rewards for correctly picking the best-performing constituents in that market.

Exhibit 1 shows average monthly dispersion figures for various segments over the 15-year period ending December 2023. The dispersion figures are calculated for different levels of granularity, including stocks, sectors, countries, U.S. styles and U.S. size segments. S&P SmallCap 600^® stock dispersion was the highest, on average, more than three times higher than the average dispersion among S&P 500^® sectors. Lower levels of dispersion were observed between U.S. size or style segments, or between countries or sectors in the S&P Developed Ex.-U.S. BMI.

So does this mean that investors would be well served to focus their attention on research into small-cap U.S. equities instead of other areas? Not necessarily: the relative value of insight also depends on the potential size of the positions that investors may be able to take in different segments.

An investor's ability to take active positions is related to the average market capitalization of constituents. For example, there is more capacity to take an active position in a trillion-dollar constituent compared to a smaller constituent. Exhibit 2 plots the average dispersion figures from Exhibit 1 against the index-weighted average constituent size of the different segments over the same 15-year period (note the log scale on the y axis).

Clearly, there has been a trade-off between dispersion and the average constituent size. Higher dispersion segments, which offer greater expected reward for correct insight, may require smaller positions compared to lower dispersion segments with larger constituents.

Capacity-Adjusted Dispersion provides a way to account for capacity when considering the potential value of insight. It is calculated by multiplying the potential reward to correct selections (dispersion) and potential size of active positions (average constituent size). Exhibit 3 shows the average ratio of capacity-adjusted dispersion measures for different segments compared to that of S&P 500 stocks, based on monthly data over the 15-year period ending December 2023.

Assuming that an investor's predictions are similarly valuable across each segment, Exhibit 3 suggests that selecting among the S&P Composite 1500^® size segments—the S&P 500, S&P MidCap 400^®, and S&P SmallCap 600—may offer more than nine times the potential opportunity compared to picking S&P 500 stocks. Similarly, choosing between the S&P 500 Growth and S&P 500 Value or selecting among S&P 500 sectors could have provided similar opportunities as picking country components of the S&P Emerging BMI or S&P Developed Ex-U.S. BMI.

Such is the difference in average constituent size that insights into S&P SmallCap 600 stocks would have to be 50 times more valuable than insights into S&P 500 stocks to provide the same capacity-adjusted opportunity.

As a result, expressing views through a U.S. size, style and sector lens could present similar opportunities as using a country lens. The relative capacity of these segments means they may offer greater opportunities than many other segments.

The equity markets roared to the finish line, easily passing commodities and bonds with a 26.3% return for the S&P 500^® in 2023. Much of that rally could be attributed to declining consumer price indices and favorable Federal Reserve guidance, with increased confidence in a soft landing. Declining inflation can best be observed at the kitchen table, where the S&P GSCI Grains saw 15% declines on the year and the S&P GSCI Livestock remained flat.

Despite another strong year of equity performance, the Dow Jones Commodity Index (DJCI) Gold maintained its top perch for this century after reaching an all-time high in December. Gold achieved a 12.8% return, outpacing both bonds and broad commodities, with the S&P GSCI recording a  -4.3% annual return. Going back to the start of the century, the DJCI Gold produced a 7.8% annual return, compared to a 7% return for the S&P 500 during that time. Adjusting for volatility, gold has demonstrated better risk-adjusted returns than stocks, with a Sharpe ratio of 0.48 versus 0.45 for equities.

Central banks appear to have taken notice in the outperformance of gold. After trading flat for much of the year, the S&P GSCI Gold and S&P GSCI Silver staged a fourth quarter rally, rising 11.4% and 7.2%, respectively. Global central banks supported gold demand, adding over 800 metric tons to their portfolios with data through October. Gold has historically provided investors an alternative to fiat currency. Digging into the central bank purchase data, countries including Russia and China have led the increase in central bank holdings. Foreign central banks appear to increasingly value gold's hedge against inflation, debt default and dollarization.

Commodity Market Recap

Energy weighed down commodity performance in 2023, with the S&P GSCI Natural Gas falling 62.6%. The decline reflects a return to the longer-term price levels observed during the past decade, as well as robust production along with reduced export demand of liquefied natural gas. The broader petroleum complex was mixed, as lower oil didn't translate to falling gas prices. The S&P GSCI Energy dropped 5.2% for the year, while the S&P GSCI Unleaded Gasoline rose 5.0%.