Will hope and reality finally collide this week?
ANTHONY SAGLIMBENE – CHIEF MARKET STRATEGIST, AMERIPRISE FINANCIAL
WEEKLY MARKET PERSPECTIVES — January 30, 2023
The path of least resistance for stock prices at the start of the new year has been clearly higher. The S&P 500 Index gained roughly +2.5% last week, while the NASDAQ Composite shot up +4.3%. In addition, the Dow Jones Industrials Average gained +1.8% on the week. Importantly, the S&P 500 closed last Friday above the psychologically important 4,000 level, sits at its highest point since early December, and is holding above its longer-term trading average. Simply, the bulls have wrestled control from the bears over the narrative (and the market) in January as anticipation of a slowdown in the pace of Federal Reserve rate hikes this week and a shallower economic downturn take hold.
And while the broad-based U.S. stock barometer is higher by +6.0% in January with just a couple of days to go before month-end, the NASDAQ has roared higher by +11.0% this month. This is because traders have quickly flocked to beaten-down areas of the market, pressing growth stocks higher in anticipation that the worst of the downturn is in the rearview mirror. To help color that point, the value-based Dow has significantly trailed behind other major U.S. averages in the January rally, increasing by just +2.5% month-to-date. Notably, some of the worst-performing growth sectors in 2022 (e.g., Consumer Discretionary and Communication Services) have been this year's best-performing sectors. Both sectors are higher by more than +14.0% in January, with Information Technology up nearly +10.0% for the month. Mean reversion, better-than-feared earnings results out of Tesla last week, and optimism that Big Tech is getting out ahead of a slowdown (see Alphabet/Microsoft layoff announcements) have been areas to help last year’s losing sectors soar higher at the start of the year. Of course, the 10-year U.S. Treasury yield falling over 35 basis points since the end of last year also doesn’t hurt.
Big tech showing gains; U.S. GDP comes in better than expected
During the week, Growth outperformed Value, with Big Tech generally higher. A better-than-feared earnings report from Tesla last week drove the stock and the Consumer Discretionary sector higher. Tesla represents over 13% of the S&P 500 Consumer Discretionary sector by market capitalization and, along with Amazon, heavily influences how the Discretionary sector performs. In addition, U.S. Treasury prices weakened, particularly in the belly of the curve, with the 10-year yield ending at 3.52%. West Texas Intermediate (WTI) oil finished the week lower by 2.5%, closing at $79.42 per barrel. And Gold snapped a five-week win streak, ending marginally lower at $1928.50 per ounce.
Adding comfort on the economic front last week was evidence that growth in the final quarter of 2022 was positive and better than expected, with U.S. GDP rising +2.9% quarter-over-quarter annualized. While overall growth slowed from the +3.2% pace seen in the third quarter, consumer spending (which accounts for nearly 70% of GDP) rose +2.1% in Q4, maintaining positive momentum despite the slight downtick from the +2.3% pace in Q3. Along with healthy consumer activity to close out the last three months of 2022, inventory investment, government spending, and nonresidential fixed investment were additive to growth in the fourth quarter. Also, the Federal Reserve’s preferred inflation gauge, Personal Consumption Expenditures (PCE), showed inflation moderating to +4.4% year-over-year ex-food and energy in December, down from +4.7% in November and hitting its lowest annualized rate since October 2021. Bottom line: The U.S. economy maintained positive momentum at the end of last year while inflation across several measures moved lower. Given solid employment trends in the U.S., a soft-landing scenario, where the Federal Reserve can help push down inflation with higher rates while maintaining flat to slightly positive economic growth, is not entirely off the table. While that scenario remains small, in our view, stocks have reacted positively to data this month that keeps the hope alive.
The Fed is widely expected to lift rates again in effort to slow the economy
But hope and reality may collide this week as the Federal Reserve delivers its first policy decision of 2023 on Wednesday. Federal Reserve Chair Jerome Powell and company are widely expected to lift the fed funds rate by 25 basis points to 4.50% - 4.75%. That would mark another milestone in the Fed’s effort to slow the pace of rate hikes to help synchronize the delayed effect on the economy from previous rate hikes and officials' need to bring down still elevated inflation. While the Fed looks to be on a persistent trajectory of slowing rate hikes from the jumbo 75-basis and 50-basis point moves last year, it is doubtful the committee will reverse course and cut rates in 2023. And that’s where hope and reality could collide for stock prices. Many market participants believe the fed funds rate will be at or below where officials are likely to target the fed funds rate after Wednesday’s decision. At the same time, most Fed officials have targeted a fed funds rate near or above 5.0% in December’s Summary of Economic Projections, which it expects to hold through 2023.
Given that backdrop, investors could look to draw out three key points from this week’s policy statement and Fed Chair Powell’s press conference.
- Has there been any change to where the committee believes the fed funds terminal rate will land, and how quickly will the rate get there?
- What economic developments is the Fed watching to determine when it will pause rate hikes?
- What circumstances would influence a decision to cut rates? In our view, Mr. Powell is likely to reiterate a staunch commitment to fighting inflation, warn that services-side inflation and wages are still elevated, and push back aggressively against any notion the Fed is considering a rate cut in 2023.
Bottom line: A “restrictive for some time” message from the Fed this week will likely be the high-level takeaway for investors. As a result, we’ll have to see how an upward-sloping stock market this month responds to an immovable Fed, unlikely to deliver the message investors want to hear. The European Central Bank and Bank of England will also provide rate decisions on Thursday. Each is expected to lift their target rates by 50 basis points.
Consumer and labor trends will be top of mind on the economic front this week; investors closely watching Q4 earnings
On the economic front this week, consumer and labor trends will be the key focus. Tuesday brings November S&P/Case-Shiller home data and January Consumer Confidence. On Wednesday, the January ADP Employment Survey and December Job Openings and Labor Turnover Survey (JOLTS) report will see outsized investor attention and leading into Thursday’s weekly jobless claims and Friday’s January nonfarm payrolls report. FactSet estimates call for nonfarm payrolls to decline to +185,000 in January from +223,000 in December. In addition, the unemployment rate is expected to rise to 3.6% in January from 3.5% in December. In our view, the labor backdrop has remained resilient and healthy over the last few months, despite a slower pace of job gains across the economy. Importantly, the employment reports this week should add another dimension to recent layoff announcements from a host of companies and provide additional context for the Fed and investors on how the labor market is holding up against slowing economic activity.
On the corporate front this week, the heart of the fourth quarter earnings season continues. During the week, 107 S&P 500 companies will report results, including 6 Dow 30 components. With roughly 29% of Q4’22 S&P 500 profit reports complete, blended earnings per share (EPS) growth is lower by 5.0% year-over-year on revenue growth of +3.9%. Only 69% of S&P 500 companies reporting results have exceeded EPS estimates, which is below the five-year average of 77%. Over the coming days and weeks, we suspect there is a risk that an increasing number of companies warn their outlooks for this year are not as healthy as some may be hoping for while possibly still beating fourth quarter estimates. The mixed messages from corporate America may create a higher degree of volatility for traders over the near term. However, investors with a time horizon of a few years or more should welcome such an environment, as it allows expectations and reality to realign. While we believe profit expectations among analysts for this year have come down quite a bit already, corporate outlooks could help again lower those expectations over the next few weeks. In our view, this is a necessary step to build a more sustainable track for stocks to recover and a healthier environment for long-term investors to begin putting cash back to work.
That said, Big Tech earnings could also be a key driver in market action this week, with Alphabet, Amazon, and Apple Inc. all reporting their quarterly profit results on Thursday. These three companies represent over 12% of the S&P 500’s market capitalization, with Apple representing 24% of the S&P 500 Information Technology Index and Amazon representing 25% of the Consumer Discretionary Index. Last week, Microsoft noted a slowdown in Cloud growth and provided a more downbeat outlook. As a result, investors will likely look to these three companies for a deeper assessment of consumer and advertising trends as well as enterprise spending plans in the year ahead.