January 2024 Market Lookback

Some would say it has been a long time coming, but the S&P 500 finally hit new all-time highs in January. Economic growth was strong in the fourth quarter of 2023, with gross domestic product growing at a seasonally adjusted annualized rate of 3.3%. Inflation data continued to be promising, with six-month annualized core PCE, one of the Fed’s preferred gauges of inflation, running at their target of 2%. However, tough talk from the Fed at the end of the month pushed back on March rate cut expectations, and fresh regional bank jitters also served to weigh on Treasury yields.

Macro

•   Q4 GDP grew at a seasonally adjusted annual rate of 3.3%, which was higher than every single economist estimate submitted to Bloomberg.

•   The FOMC held the federal funds target rate unchanged in a range of 5.25%-5.50%, with Chair Jerome Powell indicating that it was unlikely the committee would have enough certainty to cut in March.

•   December CPI came in at 3.9% y/y, just above the consensus estimate of 3.8%, while PPI came in at 1.0% y/y, below the estimate of 1.3%.

•   January consumer sentiment rose sharply according to both the University of Michigan’s Survey of Consumers (78.8 versus the prior month’s 69.7) and Conference Board’s Consumer Confidence Index (114.8 versus the prior month’s 108.0).

•   November home prices rose a little over 0.1% m/m, missing expectations of a 0.5% gain.

Equities

•   The S&P 500 reached a new all-time closing high for the first time since Jan 2022.

•   Bottom-up 2024 EPS estimates for the S&P 500 moved down to $242 in January from $244 previously, while top-down strategist estimates remained at $240.

•   Growth stocks outperformed value stocks by 2.4 percentage points, the second-most since May.

•   Buoyed by the semiconductors industry group and some of the Magnificent Seven, Communications and Info Tech were the best performing sectors.

Fixed Income

•   Though 10-year Treasury yields began the month at 3.88% and rose to 4.15% on January 24, yields finished the month at 3.91% as regional bank jitters roiled fixed income markets.

•   Similarly, fed funds futures swung between as many as seven rate cuts in 2024 on January 12 and as few as five cuts on January 30.

•   U.S. investment grade corporates issued $188 billion in bonds in January, surpassing the $175 billion in January 2017 and setting a new record for the biggest issuance month ever.

•   Option-adjusted spreads for U.S. investment grade corporate bonds fell to 96bps, the lowest levels since January 2022.

Balanced Mandate Risks

Inflation has come down faster than expected, unemployment has remained low, the stock market has hit new all-time highs, and consumer sentiment has improved. It’s hard to imagine a better past few months for the Federal Reserve’s attempt at achieving a soft landing. However, this doesn’t mean that the coast is clear. At least not yet.

The Fed has come around to the view that risks to their dual mandate of stable prices and maximum employment are in better balance. This means that the labor market has cooled some, and inflation has come off its highs. As a result, the Fed has to be more careful now and evenly weigh both sides of its mandate.

A deeper look into labor data shows us that despite persistently low unemployment, the quits and hires rates have steadily declined over the past two years, and are now down to 2017-18 levels. Workers are less likely to quit their job as their feelings about the labor market worsen, while employers generally hire fewer workers when their businesses aren’t expanding.

The challenge for the Fed is knowing just how much more, if at all, needs to be done to rein in inflation. Do too much and they jeopardize the employment mandate, don’t do enough and they risk reigniting inflation.

Supply Bogeyman Lurks

There are some things, however, that the Fed has little control over. The supply shocks of the past few years, for example, are an obvious example, as they were unpredictable and had cascading effects. It’s early, but current geopolitical tensions and conflict in the Middle East could have similar, if not as extreme, effects.

The greater frequency of attacks on ships using the Red Sea route has disrupted the flow of trade. As a result, shipping costs have spiked and are up roughly 90% y/y (after being down 70-80% y/y in 2023). If these higher costs are sustained for longer, they could affect the price of goods, energy and food. As it stands now, estimates suggest that the increase in shipping costs may push global core inflation up by ~0.1 percentage point, or in other words not very much.

However, given the region’s importance to global energy supply, a much greater supply shock could occur if the current conflicts were to broaden. It could push energy prices meaningfully higher, and as we saw in 2022, a sharp rise in energy prices can have major spillover effects. Supply-side healing helped the Fed get inflation down without much labor market pain, but further shocks could dash its hopes for a soft landing.

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