January Markets – A cautious, upbeat start to 2023
There was no shortage of gloom as the new year began. The Federal Reserve was signaling higher interest rates and its aggressive campaign, which it started last year to rein in inflation, has been threatening to throw the economy into a profit-killing recession.
While investor sentiment is far from euphoric right now, 2023 is off to a strong start. What’s behind the move?
Table 1: Key Index Returns
Last year, the Fed hiked its key lending rate, the fed funds rate, by 75 basis points (bp, 1 bp – 0.01%) in four consecutive moves.
Mix in a 50 bp increase in December and 25 bp increase back in March, and we experienced the most aggressive tightening cycle in over 40 years—1,000 bp in 6 months (St. Louis Federal Reserve) at the end of 1980. Ronald Reagan had not yet been inaugurated.
Based on the most recent 25 bp rate hike, the Fed seems to have moved to the next stage of reducing monetary policy. The first stage was raising interest rates high enough to restrict the money supply. Now it seems the Fed will shift to the “fine tuning” stage before they eventually move to the final stage of maintaining the funds’ rate at a specific level.
While the Federal Reserve is not yet signaling a halt to rate hikes and commentary suggests it could hold rates at a high plateau this year (what analysts have been calling ‘higher for longer’), the pace of rate increases is set to slow from last year’s nearly unprecedented level.
But are investors front-running the Fed? Or are they too optimistic about rates? Fed officials pushed back aggressively last year on a 2022 pivot.
Today, investors believe we may see at least one rate cut by the end of the year. Previously, that had not been in the Fed’s game plan, but Fed Chief Powell seemed less wedded to pushing rates above 5% at the February 1 press conference.
While Powell isn’t declaring victory on inflation and he isn’t ready to hint at a turnaround, he was more open to the recent moderation in inflation. The initial reaction was positive.
Looking ahead, a significant rise in the jobless rate would probably force the Fed to cut rates, but a drop in corporate profits could negate any benefits from falling rates.
We recently saw nonfarm payrolls add 517,000 jobs in January, bringing the unemployment rate down to 3.4% (U.S. Bureau of Labor Statistics), the lowest level seen since 1969.
How the Fed responds will be heavily influenced by how the economic outlook unfolds. We believe there will be at least one more hike in March and possibly another in May if the labor market remains strong.
An Opaque Crystal Ball
From 1970 through 2021, the January return on the S&P 500 Index exceeded 5% 10 times (St. Louis Federal Reserve data). Excluding reinvested dividends, the S&P 500 finished the year higher nine times. The 90% ‘win ratio’ beats the average since 1970 of 74%.
During the 10 years when January advanced by 5% or more, the S&P 500 averaged a return of 21.5%. Its best annual return was 31.6% in 1975, which followed the difficult 1973-74 bear market. Its only loss was 6.2% in 2018.
There are those who attempt to glean insights from expected market returns based on where we are in a political cycle. Such exercises are interesting, but let’s stress that each economic cycle has its own peculiarities that may override these barometers.
We know that past performance is not a guarantee of future results. Ultimately, the economic fundamentals will play a big role as the year unfolds.
We trust you’ve found this review to be educational and helpful.
If you have any questions or would like to discuss any matters, please feel free to give us or any of our team members a call.
As always, we’re honored and humbled that you have given us the opportunity to serve as your financial advisors.