The new year started with a sell-off which quickly turned to modest gains by month’s end. The S&P 500 advanced 1.5%, the DOW gained 1.2%. The NASDAQ advanced 1% in January after falling more than 2% in the final two trading days of the month. Small caps shed 4% and midcaps fell 1.8%. S&P equal weight (RSP) was down fractionally, and bonds were flat. The rest of the developed world (CWI) shed 1.1%
After the “buy everything” rally that punctuated the end of 2023, the market breadth narrowed during January, as 224 issued gained and 279 fell. Five of the eleven sectors gained in January, with communication services up the most, and real estate down the most. The “magnificent 7” accounted for 45% of the January return. Excluding Tesla (down 25%) the “Magnificent 7” cohort would have accounted for 71% of the returns for the month.
TWG growth, moderate and conservative models ended the month flat to fractionally down largely due to the tech sell off on January 30th and 31st. Their respective benchmarks were up fractionally largely due to CWI’s advance in the final two trading days. However, as of February 2, TWG growth, moderate and conservative models were up 1.03%, .84% and .64% respectively, net of fees, relative to their benchmark gaining .97%, .91% and .85% due to strength in large cap tech to start off the new month.
WHAT MOVED MARKETS
The first week of the new year we observed profit taking from last year’s high flyers, which was not unexpected. Given the sizable gains in mega cap tech as well as the buy-everything run to end 2023, deferring taxes by waiting to take profit until the new year makes a lot of sense. The profit taking was short-lived, however, as the second week of the year saw renewed buying interest, moving the broad market to within points of a new all-time high. To start the year, the NASDAQ slid 4% and the S&P 500 shed 2%
Earnings season began on January 12th with big banks reporting. The focus of much of the remaining days in January will be a show up or shut up mentality, where corporate earnings reporting will need to justify stretched valuations.
Core consumer inflation came in a bit hotter than expected but with a few areas of higher than overall inflation causing the uptick. Namely, rent rates are still showing price increases two to three times the overall rate of inflation. Used car prices, medical services and home and auto insurance were the other areas where prices increased more than the overall inflation rate. We will be keeping an eye on these data points to better anticipate the Fed’s likely course of action in the months ahead.
PPI (producer price index – the inflation reading for what companies input costs) notched down, which is favorable to support the narrative that inflation continues to wane.
The broad market was flat for the second week but up sharply for the third, reversing the initial decline from the first week. It appears that mega cap profit taking has been exhausted, as these stocks led the move higher during this advancing week. Tawain Semiconductor Corp’s favorable guidance announcement lit a fuse under the semiconductor complex, that spilled over to the broader tech sector.
On Friday January 19th the University of Michigan consumer sentiment survey implied that consumers are more upbeat about the economy than they’ve been in almost two years. Additionally, consumer forward inflation expectations declined, suggesting that inflation sentiment is not entrenched into the psyche of the American population. Both readings are favorable for the market to continue its advance before tech earnings results hit the tape.
Also, on Friday 1/19 the S&P 500 and the DOW hit new all-time highs. The last time the S&P 500 hit a new all-time high was more than two years ago on January 3, 2022.
Reported towards the end of the month, 4Q GDP came in stronger than expected, underpinning the continued strength of the U.S. economy. December PCE (personal consumption expenditures – the Fed’s preferred measure of inflation) came in at an annualized rate of 2.9%, a little lower than expected and a meaningful decline from Novembers annualized 3.25% reading. Both data points imply a soft landing continues to be the likely outcome but does challenge the consensus outlook that the Fed will cut rates aggressively this year, as strong economic output and lower inflation combined could potentially challenge inflations ongoing decline.
The final week of the month was the most important of the year, with many of the mega cap tech stocks reporting 4Q earnings, along with a Fed policy meeting. This was a week chock full of big swings, as earnings from Google, Apple and Microsoft, while positive, were not as good as investors were hoping for and those names sold off. But blow out earnings from Amazon and Meta (formerly Facebook) exceeded expectations and ripped higher. Both earnings events carried the tech complex both lower and higher, creating a week of big swings.
Last (but not least) on January 31st, the Federal Reserve held their first policy meeting of the year, keeping rates steady as expected. However, Powell, during his presser, indicated that it was likely too early to declare victory on inflation and a March start to cutting rates was probably not likely. Stocks sold off on the news, with the S&P 500 declining 1.7% and the NASDAQ slipping 2.3%
In summary, January economic data indicated lower inflation, below 3% for the first time in years; Stronger than expected GDP and consumer sentiment; strong retail sales; healthy spending and improving productivity. All positives that are supportive of a strong economy but negative from the standpoint that rate cuts are not necessary on the immediate horizon given the data’s potential to re-ignite inflation. This is something the Fed is sure to consider in its future rate setting policy.
PORTFOLIO ADJUSTMENTS
We continue to be pleased with the adjustments that we have implemented throughout the month, following trends and shifting accordingly. For example, after the surge in small caps at the end of 2023, we added a small amount of exposure to small blend and mid growth, as well as increasing our small cap value position. However, as that trend unwound and essentially died out during the first week of the new year, we quickly evacuated the small cap complex and increased exposure to large caps, which continue to carry the market forward. Stated another way, we “leaned” into small caps in the event that the trend strengthened, but when it became apparent the trend had faded, we leaned back out, avoiding a weak area of the market.
As the year started with weakness in tech/growth and strength in value, dividends and international, we also took small positions in international funds (IEV and GCOW), Deep value (RPV), and dividends (COWZ) and eased off QQQ, giving us a chance to capitalize on a potential trend change and a continued broadening of the market which started late in 2023. However, as those trends reversed, and mega cap tech continued to flex its muscle, we systematically pared down on those supporting positions in IEV, COWZ, GCOW and RPV and once again increased our exposure to tech which resumed its advance and squarely positioned us to where the strength lay via QQQ and SPLG.
We think that emerging trends will continue to be fleeting, until they aren’t, at which time we should at least have some exposure to which we will continue to accumulate if that trend continues to strengthen. However, if an emerging trend is short lived (as we’ve observed), then we flexibly back off and course correct. The strategy affords us an objective and systematic way to potentially capitalize on new trends, which will at some point be beneficial if and when the strength in mega cap tech starts to wane, which one never knows when that may occur.
LOOKING AHEAD
The market appears to be juggling the potential for the Fed to cut rates, but expectations were simply too optimistic at the end of the year. As new economic data is released, the Fed, acting prudently but clearly in no hurry to start cutting rates, will dictate the direction of the market. Much of the market movement is still based on expectations of interest rates and Fed policy, but we feel that it is safe to assume that rates are peaking, and the path of least resistance points to lower rates ahead.
As discussed in past notes, the market often trades more on expectations than on reality, and the expectations that drove nine consecutive weeks of market gains was probably overly optimistic. Add in the ongoing strong economic data over the past month, it is reasonable for the Fed to exercise patience and not start cutting rates until inflation is much close to their 2% target.
Typical of most regime changes, a period of uncertainty and volatility leads up to and follow said change. We are there now, and the market is grappling with when (not if) and why the Fed will cut rates, and if the market gets ahead of itself, adjustments will be made. It makes sense to us that when the market was largely pricing in a March rate cut but Powell stated that March is likely too early, adjustments would be made, and the market was getting a bit ahead of itself in its belief that rate cuts are forthcoming.
We’ve learned over the years not to fight the Fed. We will follow Powell’s lead in anticipation of rate cuts, and the timing will likely become clearer as more data comes in. For now, we are comfortable riding a higher trending market but also acknowledge that valuations are stretched in some corners of the market and may adjust as it becomes clearer whether inflation is still moving meaningfully to the Fed’s preferred 2% target.
Until next month…
