By Ben Norris, CFA, Securities Research Analyst, Associate Vice President
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Stocks continued their hot start to the year last week as investors continued to buy growth stocks that had been out of favor for most of 2022. The NASDAQ Composite (COMP) led the major indices higher with a 4.3% gain. COMP is now up more than 11% so far in 2023 after finishing 2022 down 33%. Still, COMP remains nearly 30% below its all-time high set in late 2021. While the S&P 500 (SPX) and Dow Jones Industrial Average (DJIA) didn’t fare quite as well as COMP last week, they still posted solid gains of 2.5% and 1.8%, respectively. Year-to-date SPX and DJIA have gained 5.9% and 2.3%. From a sector perspective, Communications Services has gone from the worst performing sector in 2022 to the leading position so far this year with a year-to-date gain of 15.2%. Consumer Discretionary, another notable prior year laggard is not far behind, up 14.5% in 2023. Generally, the worst performing sectors from the previous year tend to outperform in the next, but the textbook nature and large magnitude of the current sector performance reversal feels almost too good to be true. Similarly, the outperforming sectors of 2022 are off to a slow start so far this year. Energy, Health Care, Utilities, and Consumer Staples are all underperforming the broader market over the last four weeks.
The outperformance of growth-oriented sectors (Communication Services, Technology, and Consumer Discretionary) in 2023 aligns with the emerging view that the Federal Reserve will begin to pause rate hikes, and potentially cut rates later this year. That narrative seems premature in my opinion as Fed policymakers have gone out of their way to signal that they intend to keep rates higher for longer to ensure that higher inflation doesn’t become entrenched in the U.S. economy. So far, however, markets have disagreed. The yield on 10-year U.S. Treasuries has fallen from a peak of approximately 4.25% in the fall of last year, to around 3.5% currently. The two-year Treasury yield remains above the 10-year yield, indicating an inverted yield curve, but that yield has also declined noticeably from its recent highs. The recent decline in yields is a sign that the market has increasing confidence in the Fed’s odds of completing a return to “normal” monetary policy without pushing the economy into a recession. Better-than-expected economic growth and a resilient job market are two of the primary factors investors are likely pointing to when making their case. At the same time, other indicators, such as the Institute for Supply Management’s (ISM) Manufacturing and Services indices, are hinting that the economy is beginning to show signs of slowing. In other words, the Fed’s tighter monetary policy may be working as intended.
The fourth quarter’s earnings season ramped up last week and began on a positive note with stocks being led higher by the Technology sector in Monday’s session. The Leading Economic Index (LEI) for December 2022 was released on Monday and showed yet another decline, indicating that a recession may be on the horizon. The LEI has now been trending down for 10 straight months – a string of this many negative months has predicted a recession without fail in the past. Tuesday was the busiest day of the fourth quarter earnings season and stocks ended mixed as investors assessed earnings reports from bellwether companies such as Johnson & Johnson (JNJ) and 3M Company (MMM). Despite strong gains for markets so far in 2023, earnings season has gotten off to a shaky start at best. The earnings beat rate for SPX is below its historic average so far and estimates continue to come down. Also on Tuesday, the S&P Manufacturing and Services PMI (Purchasing Managers’ Index) were released. Both indices rose in January, albeit from multi-year low levels.
Stocks once again closed mixed on Wednesday. The DJIA ended in positive territory while SPX and COMP were weighed down by disappointing earnings reports from a few influential companies. Cautious commentary from a few of these companies’ management teams reignited concerns that the economy is slowing faster than the Fed anticipated. No major economic indicators were released on Wednesday. Thursday’s reading of fourth-quarter Gross Domestic Product (GDP) showed that economic growth was better than consensus expectations as the U.S. economy grow at a 2.9% annualized pace. Although this was slightly below the 3.2% growth rate seen in the third quarter, a comfortably positive pace of growth is a welcome change from the two quarters of negative growth seen in the first and second quarters of 2022. The data further supported the argument that the Fed can continue its path of rate hikes without the economy tipping into a recession. Stocks saw broad gains during Thursday’s session as a result.
The positive sentiment continued Friday as the Fed’s preferred measure of inflation, the Personal Consumption Expenditures Price Index (PCE), rose just 0.1% in December. The reading was in-line with consensus expectations and showed that inflation has increased 5% vs. a year ago. 5% is the lowest reading for PCE since September of 2021. Rounding out the week, the University of Michigan Consumer Sentiment Index for January came in better than expected as falling interest rates and easing gas prices have helped calm consumer nerves. While stocks have gotten off to a very good start in 2023, especially when compared to 2022, it feels like we’re overdue for a pause. Valuations have crept back up in certain areas of the market and some lower quality “meme” stocks have seen rapid gains without any fundamental support. So, while interest rates have come down a bit over the last few weeks and cleared the way for growth stocks, we may have come too far too fast.
The highlight of the coming week will be the Federal Open Market Committee’s policy statement and press conference with Chairman Jerome Powell on Wednesday. While earnings season continues this week and we will get a variety of updates on the state of the U.S. job market, investors will be waiting to see what changes, if any, the Fed will make to their monetary policy going forward.
|Monday 1/30/2023||None Scheduled|
|Tuesday 1/31/2023||Case-Shiller Home Price Index (SAAR)||-3.1%||—|
|Consumer Confidence Index||108.4||109.5|
|Wednesday 2/1/2023||ADP Employment Report (January)||235,000||190,000|
|ISM Manufacturing Index||48.4%||48.0%|
|Federal Open Market Committee Policy Statement|
|Thursday 2/2/2023||Initial Jobless Claims||188,000||195,000|
|Continuing Jobless Claims||1.68M||—|
|Factory Orders (December)||-1.6%||2.0%|
|Friday 2/3/2023||Nonfarm Payrolls (January)||223,000||187,000|
|Unemployment Rate (January)||3.5%||3.6%|
|Labor Force Participation Rate||82.4%||—|
|ISM Services Index||49.6%||50.6%|
Links to previously published commentaries can be found at benjaminfedwards.com/Latest Investment Insights/Weekly Market Commentary/Market