Equity markets continued their impressive start to the year on growing hopes for a soft landing, gaining in four of the five weeks and bringing the year-to-date gain for the S&P 500® Index to 6%. The high beta areas of the market have been strongest to date in 2023, with emerging markets, small caps, and technology leading the way. High beta stocks are at their best relative level versus the S&P 500® Index in 18 months. The risk-on rally extends beyond equities, with the Bloomberg US Aggregate Bond Index up 3% and Bitcoin up nearly 40%. Most market participants are skeptical about the durability of the rally that has seen the S&P 500 gain 14% since the October low, dismissing it as a bear market rally.
Technical indicators are increasingly supportive, as the S&P 500 has been above the 200-day moving average for a week, and the 50-day moving average will likely break above the 200-day moving average (“golden cross”) for the first time since last March in the next few days. Institutional investors and hedge funds remain conservatively positioned, and money market assets are at record levels. Wall Street strategists are also notably bearish, with the average estimate for the year-end S&P 500 below the current level, indicating that those numbers could be revised higher, the market is ahead of itself, or a combination of the two. Retail investors, however, continue to aggressively allocate to equities, with EPFR data showing $14 billion into equity funds last week, the largest in six weeks. At 70, the CNN Fear & Greed Index is at the highest level since November 2021, reflecting the shift in technicals and retail investor optimism.
The pendulum has swung swiftly and dramatically from universal pessimism to optimism, but that could quickly reverse with a Hawkish message from Chair Powell this week. Given that skepticism of this rally is so prevalent, it may not take much to swing the pendulum back the other way, setting ourselves up for a short-term pullback over the next several weeks. However, if we forecast out 12 months from now, we believe this period will show itself to be a good buying opportunity.
The FOMC meeting convenes this week, with the Fed Futures curve embedding a near-100% chance of a 0.25% rate hike, bringing the upper band to 4.75%. The March meeting six weeks later has an 85% chance of an additional 0.25%, but a 15% chance that the Fed pauses. The curve embeds a peak in June, followed by three cuts over the following year, though the Fed and most market observers are not anticipating aggressive stimulus unless the economy deteriorates substantially. Chair Powell’s statement and press conference will be closely watched, with a potential pushback against easing financial conditions, which are much looser than his Jackson Hole speech which was viewed as hawkish.
With nearly one-third of S&P 500 companies having reported fourth-quarter results, earnings are heading for a decline of 5%, marking the first decline in nine quarters. For companies that generate more than 50% of sales inside the U.S., the blended earnings decline is -3.5%, and for companies with more than 50% of sales outside the U.S., the decline is -7.3%. Interestingly, companies that beat are seeing a 1.5% rally, but companies that miss are rallying 0.7% versus a five-year average of a 2.2% decline. Trends from conference calls include a slowing but resilient consumer, weak corporate investment, and inventory reduction. A 5% decline in earnings on 4% sales growth reflects significant margin pressure.
Economic data is sending mixed signals, with most measures of current activity still encouraging, while gauges of future activity point to a slowdown. GDP growth in the fourth quarter was a better-than-expected 2.9%, though economist forecasts are for a decline in the first and second quarter of 2023, similar to the trend in 2022. The PCE deflator (the Fed’s preferred inflation metric) rose 5.0% from a year ago, with the core PCE deflator up 4.4%, both in line with consensus and an improvement from November. The PCE deflator exceeded personal income (+4.6%) on a year-over-year basis for the 12th consecutive month. Personal spending grew by 7.4% from a year ago but moderated versus November on decreased spending on housing, transportation, and healthcare. The Citi Economic Surprise Index has turned negative, as numbers are increasingly missing economists’ expectations, and high-frequency data suggests the economy is growing at a 0-1% real rate.
What to Watch
The FOMC announcement on Wednesday will be the primary focus of investors, while earnings season will continue to influence markets. Economic data include consumer confidence on Tuesday, ISM and JOLTS data on Wednesday, durable goods on Thursday, and the monthly payroll report on Friday.
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