Good News is Bad News: Encouraging Macro Economic Data is a Risk for the Market

Thoughts

• Equity markets look to continue their strong start to the year that has seen the S&P 500® Index advance in four of the five weeks of 2023. The Index is now up 8% for the year and 16% since the September low. High-beta equities have led the way, with the NASDAQ surging by nearly 17%, the S&P Small Cap 600® Index hitting a record high, and the MSCI Emerging Markets® Index gaining 10% through Thursday. Most institutional investors and Wall Street strategists remain skeptical of the year-to-date returns, suggesting we are in a bear market rally. Markets have quickly moved to overbought conditions and are susceptible to a near-term pullback on disappointing macro data or a perceived shift in the path of Fed policy.
• The surge in risk assets to start the year has triggered some unusual market behavior. Retail activity as a percentage of the total market is at a record high, reflecting the buy-the-dip mentality, and has hints of the “gamification” of the market seen in 2021. Options purchases on Thursday were a record, with 40 million calls versus 28 million puts. The five-day average put/call ratio of 0.86 is the lowest since 2021. Hedge funds, which had been conservatively positioned, have been aggressively covering shorts at the most aggressive level in a decade, per Goldman Sachs.
• With a better-than-expected jobs report on Friday, good news is bad news for the market. For institutional investors who have been predominately on the sidelines, the rush to exit losing positions late last week was too much too soon. They risk reverting to bearish positions as soon as the market pulls back. With so much emotion driving institutional investors, retail investors seem calm and measured by comparison.

News

• The job market remains incredibly resilient, with job growth of 517k in January, nearly triple the consensus of economists of 185k, and roughly double the upwardly revised gain of 260k in December. This markets the 10^th consecutive upside beat for job growth versus forecasts. The unemployment rate fell to 3.4% from 3.5% last month, the lowest level since 1969 despite a rising labor force participation rate. Strength was broad-based, with notable growth in leisure and hospitality, professional and business services, and healthcare. Wage growth was healthy at 4.4% from a year ago, though wages have lagged CPI for 22 consecutive months. The report’s strength surprised investors, particularly because of the wave of layoff announcements from high-profile companies, driving equities lower and higher rates. Unemployment claims at 183k were the lowest since April, while the JOLTS report showed 11.0m jobs remain open.
• Roughly half of the S&P 500 companies have reported earnings, with earnings heading for a decline of 5% on 4% revenue growth. Both the percentage of companies beating estimates and the magnitude of those misses are well below historic levels, though the reaction to earnings misses has been dramatically better than in the past, reflecting the pessimism that was priced into shares. Themes for the quarter include cost-cutting actions, moderating cost pressure, easing supply chain bottlenecks, weak corporate demand, and a resilient consumer. High-profile technology companies, such as Apple, Amazon, and Alphabet (Google’s parent company) delivered disappointing results on Thursday, though all three had very strong positive moves for the week.
• Investors are increasingly betting on a soft landing following a batch of encouraging economic data, with former Treasury Secretary Lawrence Summers and IMF Director Kristalina Georgieva noting the odds are improving over the weekend. Last Wednesday, the FOMC announced a well-telegraphed hike to the Fed Funds rate of 0.25%, bringing the top-end of the target to 4.75%. Chair Powell’s tone in the press conference was viewed as substantially less hawkish than in previous meetings, stating that the disinflationary period has started, and saying he is not unnerved by the easing of financials and runup in risk assets. The Fed Futures curve has shifted upward, with two hikes now embedded through July, followed by two cuts through next January.

What to Watch

• With the FOMC meeting behind us, earnings season beginning to slow, and key economic data having been recently released, this week will be largely devoid of catalysts. Economic releases include consumer credit on Tuesday and consumer sentiment on Friday.