Hopeful exuberance continues to win the market sentiment battle

ANTHONY SAGLIMBENE – CHIEF MARKET STRATEGIST, AMERIPRISE FINANCIAL

WEEKLY MARKET PERSPECTIVES — February 6, 2023

In our previous Market Perspectives report, we pondered if investors' “hopeful” exuberance this year would finally collide with the Federal Reserve’s message of a more uncertain reality. For argument's sake, we’ll say hope continues to win the battle. The S&P 500 Index rose +1.6% last week, the NASDAQ Composite popped higher by +3.3%, while the Dow Jones Industrials Average finished down 0.2%. Although stocks ended last week on a sour note and following the January nonfarm payrolls report on Friday (more on that below), the NASDAQ finished its fifth straight winning week.

The S&P 500 Index is now higher by +15.6% from its October 12 low and gained more than +6.0% in January for its best start to the year since 2019. For the NASDAQ, the tech-heavy Index added +10.7% in January for its best start to a year since 2001. And while that last point may strike some fear in investors old enough to have lived through the dot-com bust, performance for the rest of the year tends to be solid following substantial stock gains in January. According to Bespoke Investment Group, since WWII, when the S&P 500 moved higher in January, the Index has gained another +10.9% for the year on average. This is better than the +7.4% average for all years and the +2.1% average when the Index closed January lower. Moreover, going back to 1985, the S&P 500 has averaged a February gain of +0.4%, which matches the 10-year average return. Unfortunately, the S&P 500 tends to produce mixed February results in years where the S&P 500 gained +5.0% or more in January (as it did this year).

In our view, asset prices responded quite well to a flurry of incoming data, a heavy earnings calendar, and high-profile central banker meetings last week, despite the details of each running the spectrum in creating positive to negative catalysts for markets moving forward. Nevertheless, Big Tech was a big hit with investors last week. Communication Services (+5.3%), Information Technology (+3.8%), and Consumer Discretionary (+2.3%) led the S&P 500 higher. In addition, generally positive investor reactions to highly anticipated profit reports/outlooks/commentaries from Meta Platforms, Apple, Alphabet, and Amazon helped not only these index behemoths largely skate through the earnings season unscathed but added fuel to the growth rally that has taken investors by surprise at the start of the year. Bottom line: Big Tech profits are on a downtrend, but results  and outlooks were not as terrible as feared. Here, less bad news appeared to be good news for stock prices.

The dollar shows strength; a shockingly robust January jobs report turns ‘good news into bad news’ for markets

Outside of stocks, the U.S. dollar was stronger against the major currencies last week. However, Gold (down 2.4%) posted its biggest weekly loss since October, following six straight weeks of gains. In addition, West Texas Intermediate (WTI) oil settled lower by nearly 8.0% as investors started questioning the potential strength of China’s COVID-19 recovery.

U.S. Treasury prices were mostly weaker last week, with the yield curve flattening. The 2-year Treasury yield ended at 4.31%, while the 10-year yield finished at 3.54%. Strength in Treasury prices faded at the end of the week after the Labor Department reported the U.S. economy added a stunning +517,000 new jobs in January, the strongest monthly job gain since July 2022. In addition, the unemployment rate sank to 3.4%, the lowest jobless level since May 1969. Notably, job growth was broad-based across industries last month, with leisure and hospitality adding a whopping 128,000 new jobs. And while the January nonfarm payrolls report crushed estimates, wage growth was mostly in line with expectations. The overall takeaway? Employers, in aggregate, aggressively added to staff last month, despite high-profile layoff announcements suggesting the contrary. At the same time, average hourly earnings did not spike higher, meaning the addition of new payrolls in January was accomplished without putting an upward strain on labor inflation — a positive sign for employers moving forward.

Nevertheless, the shockingly robust January jobs report, combined with roughly 11 million job openings in December (nearly two jobs for every available worker), certainly complicates the Federal Reserve’s calculus in slowing the economy down to lower inflation. And while seasonal factors may have played a role in the unexpectedly large pop in job gains last month, there is little doubt the employment backdrop remains an incredibly strong pillar of the U.S. economy. Bottom line: Evidence of its continued resiliency, combined with falling inflation, continues to fuel a building soft-landing thesis for the economy in 2023, which has been the dominant catalyst in lifting asset prices this year.

Speaking of the Fed, as expected, the Federal Open Market Committee (FOMC) raised its fed funds target rate by 25 basis points last week — marking the Fed’s eighth consecutive rate hike for this cycle. As a result, the fed funds rate currently stands at 4.50% to 4.75% — the highest level since October 2007. There was little change to the policy statement though officials recognized that inflation “has eased somewhat but remains elevated.” But it was really the market’s interpretation of Fed Chair Jerome Powell’s press conference following Wednesday’s announcement that had investors cheering.

The market interpreted Mr. Powell’s limited pushback on easing financial conditions over recent weeks and his focus on longer-term conditions (which have tightened due to higher rates) as a sign the Fed isn’t overly concerned with the recent rally in the stock market. He also somewhat talked up a soft-landing scenario, with his base case still calling for inflation to drop to 2.0% without a substantial drop in employment. And because the Fed Chair didn’t slam the door on the idea that updated economic projections in March could show a lower terminal rate or push back on the narrative the Fed could cut rates later this year if inflation falls faster than expected, investors grinned in relief as their hope of easier policy by yearend lives on. Bottom line: The bulls heard what they wanted to hear last week. Without Mr. Powell pushing back aggressively against a more sanguine view of the macroeconomic environment, investors used the opportunity to keep pressing stock prices higher last week.

The Bank of England and the European Central Bank lift target rates; U.S. consumer confidence weakened slightly

Overseas, the Bank of England (BOE) and European Central Bank (ECB) lifted their target rates by 50 basis points. But as Bloomberg noted, ECB President Christine Lagarde may be the last hawk standing. Both the Federal Reserve and BOE suggested future rate hikes may be smaller, each hinting that they are likely close to the end of their tightening cycle. Conversely, Mrs. Lagarde stressed an additional 50-basis point hike was in the cards for March, with the potential for similar moves thereafter if conditions warrant. While the ECB started hiking rates later than the BOE and Fed, and inflation pressures are still very elevated across the region, the ECB’s rhetoric stands in clear contrast to investors growing belief global inflation risks are diminishing.

Back at home, headline consumer confidence weakened slightly in January, and ISM manufacturing activity slid further into contraction. However, ISM services activity unexpectedly strengthened last month, moving back into expansion, with new orders and respondents noting a solid demand environment and easing supply chain pressures. Importantly, disinflation and efficiency are top-of-mind for investors and could continue to be a principal focus for the market. Thus far, inflation, bond yields, and the U.S. dollar have all been on a steady downtrend this year. Each has added more credibility to a building narrative that suggests the slowdown in economic activity and corporate profits this year could be more manageable than initially feared. Meta CEO Mark Zuckerberg's comments last week declaring 2023 was a "year of efficiency" for the company can be easily translated into a broader theme for other Technology companies as well as corporate America. Scrutinizing hiring, re-evaluating projects, and reducing management layers are actions companies, large and small, are likely to initiate this year. This type of focus across corporate America could help mitigate earnings pressures and protect profit margins.

This week, the pace of head-spinning macroeconomic data slows considerably. The only two meaningful reports this week are jobless claims on Thursday and a preliminary look at February Michigan Sentiment on Friday. In addition, President Biden will deliver his State of the Union address on Tuesday, while the fourth quarter earnings calendar remains heavy throughout the week. 95 S&P 500 companies are scheduled to report results. With roughly 50% of S&P 500 fourth quarter reports complete, blended earnings per share (EPS) is down 5.3% year-over-year on revenue growth of +4.3%. However, given elevated economic slowdown and recession concerns, analysts lowered their first quarter EPS estimates by 3.3% in January — over twice the rate typically seen over the last five years. But for now, investors appear unbothered by the reduced profit outlook for Q1 and continue to take a glass-half-full approach.