Markets Rebound in January
Markets rallied to start the year, with all three major U.S. indices seeing positive returns in January after experiencing declines in 2022. The S&P 500 rose 6.28 percent, the Dow Jones Industrial Average rose 2.93 percent, and the technology-heavy Nasdaq Composite rose 10.72 percent. Equity markets were supported by falling long-term interest rates.
Per Bloomberg Intelligence, as of January 31, 2023, with 45 percent of companies having reported actual earnings, the average earnings decline for the S&P 500 in the fourth quarter of 2022 was 2.3 percent. Although this is slightly better than the 3.3 percent decline forecasted, if earnings decline for the fourth quarter, it would represent the first quarter with a year-over-year decline since the third quarter of 2020. Analysts are also forecasting continued earnings declines in the first half of 2023.
All three major U.S. indices ended above their respective 200-day moving averages, marking the first month that all three have finished above trend since December 2021. Although a one-month trend is not enough to say investors are now bullish on U.S. equities, technical support was still an encouraging sign.
The MSCI EAFE Index of developed international companies gained 8.10 percent while the MSCI Emerging Markets Index increased 7.91 percent. Technical factors were also supportive, as both the developed and emerging market indices finished above their respective 200-day moving averages—marking the first time the MSCI Emerging Markets Index finished a month above trend since June 2021.
For bond markets, long-term rates fell; the 10-Year U.S. Treasury yield declined from 3.88 percent in December to 3.52 percent in January. The Bloomberg U.S. Aggregate Bond Index gained 3.08 percent and the Bloomberg U.S. Corporate High Yield Bond Index gained 3.81 percent. High-yield credit spreads tightened, indicating investors grew more comfortable taking on additional credit risk at lower yields.
Falling Rates Support Markets
The drop in rates was driven by signs of slowing inflation and expectations for slower rate hikes. Headline producer and consumer prices declined in December. Inflation is high on a year-over-year basis, but December price reports showed encouraging signs of declining price pressure across the economy.
Cooling inflation helped support increased investor expectations for a slowdown in the pace of Federal Reserve (Fed) rate hikes in 2023 compared to 2022. Futures markets project one additional 25 basis point (bp) hike this year following the 25 bp hike in February and the 4.25 percent of rate hikes we saw in 2022. If expectations prove to be accurate, it would represent a notable slowdown in the pace of rate hikes.
Economic Growth Slows
Other economic data reports released showed signs of a continued economic slowdown. Consumer spending fell for the second consecutive month to end 2022, and business confidence and investment also slowed at year-end. Given the signs of economic slowdown, it’s possible we’ll enter a recessionary environment at some point this year. If we do see a recession in 2023, it’s expected to be mild.
Job growth remained strong at the end of 2022, which should help support the economy in the case of a potential recession. Consumer confidence also showed signs of improvement toward the end of last year and start of this year. The University of Michigan consumer sentiment index finished January at its highest level since April 2022, signaling increased consumer optimism.
A further slowdown in economic growth could encourage the Fed to keep rate hikes this year to a minimum. While no one roots for a recession, relatively healthy economic fundamentals indicate that a recession in 2023 would likely be mild and could be beneficial investors in the long run.
Housing sales continued to fall at year-end, due to high prices and mortgage rates along with a lack of supply of homes for sale. As you can see in Figure 1, the annualized pace of existing home sales fell throughout 2022, with the December result bringing the pace of sales to its lowest level since 2010. The housing sector will be important to monitor going forward.
Figure 1. Total Existing Home Sales, Seasonally Adjusted Annualized Rate, 2010–Present
Source: National Association of Realtors, Bloomberg, as of January 31, 2023
Risks Remain
It was a positive start to the year for investors, but there are very real market risks to monitor. The primary risk in the U.S. is political, as the debt ceiling confrontation is set to drive uncertainty for markets and the economy until it’s resolved. This process could play out over several months and markets would likely face additional volatility if a compromise cannot be reached in a timely manner. Investors will also be keeping an eye on equity fundamentals given the expected earnings decline in the fourth quarter.
International risks should also be monitored as uncertainty overseas remains. Even though the direct market impact from the Russian invasion of Ukraine declined throughout 2022, the continued conflict could lead to further flare ups and uncertainty for the region and investors. Additionally, China’s efforts to reopen its economy bear watching, as any slowdown in the reopening process could spook investors.
Other risks might materialize and negatively impact markets at any time. Last year was a good example of the impact that unknown risks present, as the Russian invasion of Ukraine and the surge in inflation year drove investors across asset classes into the red. The market impact from those risks diminished but serve as a reminder that we may see further turbulence ahead.
There are several risks for investors as we kick off 2023, but the picture is positive. While there is the potential for short-term market turbulence, the relatively solid economic backdrop should help support long-term performance. Given the prospects for short-term uncertainty, a well-diversified portfolio that matches investor goals with timelines remains the best path forward for most. As always, reach out to us to discuss your current plan if you have concerns.
All information according to Bloomberg, unless stated otherwise.
Disclosure:ertain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Bloomberg Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Bloomberg government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The Bloomberg U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below. Authored by Brad McMillan, CFA®, CAIA, MAI, managing principal, chief investment officer, and Sam Millette, manager, fixed income, at Commonwealth Financial Network®. © 2023 Commonwealth Financial Network®
