As January Goes…
Devised in 1972 by Yale Hirsch, the creator of the Stock Trader’s Almanac, the January Barometer states that as the S&P 500 goes in January, so goes the year. We certainly hope that is the case this year, but is it reasonable to expect it to be? Will recent strength continue, or will the headwinds of rising interest rates and a slowing economy prove to be too much to overcome?
Equities finished higher last week with the S&P 500 rising 2.5% and the Nasdaq showing even better with a 4.3% gain. It seems the path of least resistance for the stock market, at least for now, remains to the upside. Markets were able to shrug off a large volume of earnings releases which generally undershot expectations. When it comes to earnings, the bar may already have been lowered, explaining why weaker than expected reports are doing little to jar markets. Fortunately, while many earnings reports have been underwhelming, very few have been what we would consider to be catastrophic.
The economic releases of the past week did not contain any real surprises with the preliminary reading of fourth quarter GDP coming in at a seasonally adjusted annual growth rate of 2.9%, slightly higher than expectations. Core Personal Consumption Expenditures (PCE) showed an annual price raise of 4.4%, the lowest reading since April 2020. Inflation appears to be trending downward but remains above the Fed’s comfort level of 2% and therefore it is highly unlikely anything will derail the Fed from continuing to raise interest rates at their meeting this week.
Many of the stocks that performed very poorly last year are leading the stock market to its best start since 2018. Much of this strength is likely attributable to buying back positions sold in December to tax loss harvest, covering of short sales, as well as longer-term interest rates falling over the past several weeks. This may not last since many of these names are speculative with stock prices predicated upon the present value of future earnings projections, which are highly dependent upon interest rates. It seems the market may have overshot expectations for future interest rate cuts and if rates do indeed stay higher for longer, as the Fed presently forecasts, then many of these stocks will continue to face headwinds. But we also feel there will be plenty of opportunity in the market over the coming year, especially for those companies with strong balance sheets and solid cash flows. Quality names are likely to prevail.
It is difficult to prove any market anomaly is related to the calendar. Sure, there are historical statistics that might show a correlation between the two, but correlation certainly does not imply causation. One such example is the Super Bowl indicator, which supposedly says the stock market’s performance in a given year can be predicted based upon the outcome of the Super Bowl. Obviously the stock market and Super Bowl are two unrelated events and any correlation drawn between the two is merely coincidental. Calendar anomalies can be influenced by financial trends and based upon investor psychology and the business cycle. Studying trends and understanding where we are in the business cycle are more likely to lead to investing success than a non-related indicator, or even historical data.
The economic reports of the past week were not disappointing and, in some regards, could be viewed as being positive, especially the headline numbers. But looking deeper into each, weaknesses are beginning to show. When adjusted for inflation, sales growth was actually lower than it was a year ago. Household demand is decelerating with incomes and spending slowing. Recent declines in inflation are likely in part being caused by lower demand, which is a sign of slowing economic growth.
Most investors welcome the positive sentiment of the markets, but the bearish case still has not gone away. Layoff news has now moved beyond tech with companies in other sectors, such as industrials and consumer goods, also announcing layoffs. The yield curve remains profoundly inverted, continuing to signal a slowdown in economic growth, and most likely a recession. A wide divergence remains between market expectations for interest rate cuts by the Fed in the second half of this year and consistent messaging from Fed officials advocating for a higher-for-longer approach. Many economic indicators are showing signs of a slowdown; most notably the Conference Board Leading Indicator Index which has been negative for two consecutive months. Over the past 50 plus years, two or more negative readings have preceded a recession 100% of the time. We like to remind readers that the economy and stock market are not one in the same and generally the stock market is a leading indicator. The current strength very well could be an indication of better things to come, including increasing chances the Fed will be able to engineer a soft landing.
The much-anticipated Fed meeting on Tuesday and Wednesday will drive market-related headlines this week and has the potential to cause large moves in the market. Current expectations are for another quarter-point interest rate hike. It is the statements after the meeting that are likely to move markets the most and it seems doubtful the Fed will back down from their current higher-for-longer stance. With this move, the Fed Funds rate will be above the Fed’s favored measure of inflation, the Core PCE rate, for the first time since 2019. Inflation reports the next few months will continue to garner larger than usual emphasis since they will drive future Fed action. Surprises to the downside could be the signs the Fed needs to pause and possibly even pivot, but we view the latter as being unlikely in the near future. The monthly employment reports will be released on Friday and are expected to show continued strength in the labor markets. These continued to be monitored closely since the Fed will have little reason to alter course as long as the labor market remains strong.
We genuinely hope the January Barometer does hold true, especially given how strongly markets have performed to begin the year. However, we caution there is much brewing under the surface and it seems inevitable there will be some undercurrents, with chances that even if markets continue with positive momentum there are bound to be speedbumps along the way. If you would like to ensure your portfolio is positioned for whatever might happen, please contact us to discuss further.
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
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