Federal Reserve appears it can have its cake and eat it too
ANTHONY SAGLIMBENE – CHIEF MARKET STRATEGIST, AMERIPRISE FINANCIAL
WEEKLY MARKET PERSPECTIVES — January 29, 2024
Major U.S. stock averages notched another week of gains, led by the Russell 2000 Index. Energy led S&P 500 sectors higher on the week, while Consumer Discretionary brought up the rear, finishing the week lower. U.S. Treasury prices were generally firmer across the curve last week, with the 10-year yield little changed on the week. Gold edged lower by less than 1.0%, the U.S. Dollar Index was flat, and West Texas Intermediate crude rose +5.9% last week on the back of cold weather disruptions, demand optimism, and ongoing tensions in the Middle East. Notably, with just a few days left in January, most major U.S. stock averages are sitting at or near all-time highs and on the cusp of notching their third consecutive month of gains. With just three trading days left in January, the S&P 500 Index is higher by +2.5% month-to-date.
“When January's performance is stronger than average, history shows the Index tends to produce a stronger return for the year relative to years where January's performance isn’t as hot."
Anthony Saglimbene - Chief Market Strategist, Ameriprise Financial
Interestingly, the old market adage “as January goes, so goes the year” may bring the bulls some added comfort this year if stocks can hold their stronger-than-average gains through the final days of the month. Bespoke Investment Group recently noted that in the last thirty-one years, going back to 1953 when the S&P 500 was higher by +2.0% or more in January, its median performance for the rest of the year was a gain of +13.5% with positive returns 84% of the time. This compares favorably to the forty years when the S&P 500 was either up less than +2.0% or down in January, which produces a +6.4% median gain through the rest of the year and a positive result 68% of the time. Bottom line: When January's performance is stronger than average, history shows the Index tends to produce a stronger return for the year relative to years where January's performance isn’t as hot. While history isn’t a guarantee of future returns, a solid end to January may have the bulls cracking a grin as we roll into February.
Soft-landing scenario likely began in final quarter of 2023
Outside of Big Tech again in rally mode, which is principally responsible for moving U.S. stock averages higher in January (see our previous Weekly Market Perspectives report for more detail), investors have now received a batch of economic data this month that suggests the soft-landing scenario likely began in earnest in the final quarter of last year.
In December, the U.S. economy added +216,000 jobs, and the unemployment rate stood near a multi-decade low at 3.7%. Disinflation trends remained on point last month (after inflation fell aggressively throughout 2023), while inflation “expectations” continued to move lower at the end of last year. At the same time, consumer confidence unexpectedly rose at a fast clip in December, indicating consumers, who drive roughly 70% of the economy, are beginning to finally feel better about their personal financial condition. Note: A working consumer who feels better about their individual financial condition is generally a consumer who is additive to economic activity. And staying on the subject of the consumer, December retail sales came in stronger than expected, while this week, we learned the U.S. economy grew by a very strong +3.3% in the final quarter of 2023. That pace of growth was much stronger than the +2.5% growth expected. Now, tie in U.S. manufacturing activity in December unexpectedly moving into expansion and services activity remaining in expansion, and it's hard to ignore the tailwinds on stock prices from positive growth, a solid consumer, and falling inflation. Finally, if that’s not enough to charge up the bulls, then Friday’s December core Personal Consumption Expenditures Price Index (the Federal Reserve’s preferred inflation measure) came in at +2.6% year-over-year, its lowest level since February 2021.
Bottom line: The Fed appears it can have its cake and eat it too. In the final quarter of last year, GDP was stronger than most expected, inflation declined more than many expected, labor trends remained solid, and consumer spending and expectations improved. Although the lagged effects of higher interest rates remain a concern today, and the bears can point to the potential the Fed will leave rates too restrictive for too long, policymakers sure look like they are preparing for an attempt to stick the landing. Given the S&P 500 is higher by nearly +19% over the previous three months, while the NASDAQ is up an eyepopping +22% (and again outside of the Big Tech influences on the broader averages), we believe an increasing number of investors are beginning to gain more confidence that the Fed will do just that. That is, bring inflation down to target without an outsized jump in unemployment or causing a recession. In our view, it comes down to the Fed effectively managing rate policy this year and remaining acutely attuned to changes in economic conditions over the coming months. Investors will likely press Fed Chair Powell this week at his press conference on that point and following the first Federal Open Market Committee meeting of 2024, which begins Tuesday.
Of course, Fed rate cut expectations for this year have been dialed back this month based on the strong incoming data, and government bond yields have trended higher. But the outsized performance gains across the usual suspects in January (e.g., the Magnificent 7) have countered rate headwinds and changes in monetary policy expectations. That said, the investment landscape remains challenging at the start of the year, particularly given that asset prices largely reflect a near-perfect landing for the economy in 2024. January’s strong performance out of the Magnificent 7 combined with still muted trends everywhere else could indicate some investors still may not fully buy that the U.S. economy is completely out of the woods. As a result, last year’s established trend of Big Tech leading the charge (due to visible, predictable and outsized growth opportunities) continues to play out at the start of 2024.
China’s outlook remains heavily clouded
Finally, the European Central Bank and Bank of Japan left rate policy unchanged last week, largely as expected. The People’s Bank of China said it would cut its reserve requirement ratio by 50 basis points starting later this week in an effort to help stabilize financial conditions. Equities across China and Hong Kong have started the year poorly, adding to their outsized losses over the last twelve months, which stand in stark contrast to the strong gains across the rest of the world over the previous year. Over the last three years, China’s CSI 300 Index is down by roughly 40%. In our view, growth concerns, a deflating property bubble, demographic issues, a battle with deflation, and, thus far, guarded policy responses have cast a heavy cloud over the outlook for China.
The week ahead
Eat a big breakfast this week because investors will be busy. Not only will over 20% of the S&P 500 report fourth quarter earnings results this week, but key reports out of Apple, Amazon, Alphabet, Meta Platforms, and Microsoft will likely heavily influence the broader averages. How influential are these companies to the fourth quarter profit narrative? Let’s just say their influence cannot be understated. According to FactSet, six of the seven companies in the Magnificent 7 (which five report this week) are projected to be the top six positive contributors to year-over-year earnings growth for the S&P 500 in Q4’23. In aggregate, these six companies are projected to grow earnings by nearly +54% in the fourth quarter versus one year ago. Exclude these six companies from the equation, and the Q4’23 blended earnings growth rate for the other 494 S&P 500 companies in aggregate would fall to a decline of 10.5% year-over-year. The Magnificent 7 are higher over the last year because they are generating almost all of the S&P 500’s profit growth. And outlooks from this week’s Mag 7 earnings releases will almost certainly be a critical driver in shaping the trajectory of their stock prices through the rest of the quarter and could also play a heavy influence on the broader market as well.
And if that wasn’t enough, a Fed policy meeting and a heavy dose of key economic releases this week flood the calendar. On Wednesday, the Federal Reserve will likely hold rate policy steady. However, investors will parse through the policy statement, looking for any subtle shifts in language that may suggest the timing of potential rate cuts this year. And if investors don’t see any clues there, expect reporters to press Fed Chair Powell rather hard in his press conference following Wednesday’s policy update as to when he sees the start of a potential pivot toward easier policy. We expect stock reactions this week to center largely on changes in market expectations around the timing and magnitude of potential rate cuts following the Fed meeting.
On the economic docket this week, a batch of home data, January ISM manufacturing, a fresh look at consumer confidence, and important updates on the labor front will also compete for attention. On Tuesday, the Job Openings and Labor Turnover Survey (JOLTS) should show that roughly 8.72 million jobs remained open in the final month of 2023. Notably, FactSet estimates suggest nonfarm payrolls this month decelerated to +175,000 jobs from the +216,000 pace in December. The unemployment rate is also expected to tick higher to 3.8% in January from 3.7% in December. Although Friday’s employment figures will be released after the Fed delivers its policy update, we suspect the expectation of decelerating job growth in January and further evidence of declining inflation may prompt tougher questions on why Mr. Powell and company need to leave rate policy so restrictive.
These figures are shown for illustrative purposes only and are not guaranteed. They do not reflect taxes or investment/product fees or expenses, which would reduce the figures shown here. An index is a statistical composite that is not managed. It is not possible to invest directly in an index. Past performance is not a guarantee of future results.