January 2024 Review and Outlook

Executive summary

• Equity markets moved higher to start the year despite early weakness
• Q4 Earnings are off to a slow start with EPS surprises and growth below-average 
• Large caps took back the leadership position, with small caps underperforming
• The yield curve continued to steepen with Fed rate cuts coming into focus
• Strong Q4 GDP Print (3.3% SAAR) well ahead of ~2% expectations
• PCE inflation slowed, with headline PCE at 0.17%

The year started with a cautious tone as large caps regained their leadership position, with overbought conditions and stretched positions, as small caps slid. Despite concerns, the prevailing narrative leaned toward a soft landing, supported by robust economic releases. Although the December CPI report showed higher headline numbers, core prices remained steady, and subsequent reports indicated flat core prices. While there were worries about regional manufacturing indicators, Q4 GDP exceeded expectations, and December retail sales indicated a resilient consumer. 

Moreover, we saw elevated volatility in Fed rate expectations. Initial positioning pointed to a 70% chance of a March interest rate cut, but after comments from Fed speakers, including Governor Waller, those expectations fell drastically. The January Fed meeting left options open, removing some hiking bias but expressing caution about a cut until there’s confidence in sustainable inflation toward the 2% target. The market ended January with a roughly 35% chance of a March cut. 

Despite the caution, the overall market direction skewed higher, though debates persist. While there wasn’t exactly a clear signal from the January FOMC meeting, the Fed is expected to cut in the coming months and taper its QT program. Economic data supports ongoing strength, consumer activity remains robust, and buybacks are poised to recover post-Q4 earnings season. Concerns linger about narrow market leadership, stretched sentiment indicators, and indices returning to all-time highs.

Treasuries experienced overall weakness, resulting in a steeper yield curve. The 30Y yield surpassed 4.40% but pulled back slightly by the end of the month following the Treasury’s lower-than-expected Q1 borrowing estimates and the quarterly refunding update. After three consecutive months of decline, the dollar strengthened notably, with the DXY rising by 2.3%. Oil rebounded from a three-month decline, with WTI crude settling up 5.9%.

Q4 earnings have fallen short of expectations, corporate layoffs are gaining attention, and regulatory scrutiny on AI, a recent performance driver, is emerging. Geopolitical factors remain a wildcard, while political uncertainty may escalate with the advancing presidential campaign in the US.

GDP: 

Headline Inflation YoY:

Supercore Inflation YoY:

Earnings: 

According to FactSet, with 35% of S&P 500 companies reporting Q4 earnings, the results have been subpar. As of the end of the month, the blended earnings growth rate stood at (1.0%), falling short of the anticipated +1.6% growth projected at last quarter’s conclusion. This was primarily attributed to the financial sector, where many banks reported lower-than-expected net interest income. Additionally, larger-cap names faced challenges, including potential impacts from an FDIC special assessment.

Energy stocks reported the largest EPS upside with an average beat of 21.6%, distantly followed by Health Care, which beat by an average of 12.1%. Top-line beats have also been led by Health Care companies reporting 2.3%, followed by Communications at 2.2%.

On the growth front, 60% of companies have reported revenue growth, with 34% declining and 6% flat, with an average growth rate of 3.6%. Energy, Materials, and Utilities companies have seen the biggest drop, with only 25% reporting revenue growth, with declines of 6.9%, 5.8%, and 3.8%, respectively. On the flip side, Communications had the highest percentage of companies with revenue growth, as 88% saw improvement, followed by Real Estate and Consumer Discretionary, which each saw 71% of companies grow revenues. Technology, Communications, Health Care, and Consumer Staples all reported average growth between 5.7-6.5%. 

The forward 12-month PE for the S&P 500 is 20.8, which is above the five-year average (18.9) and 10-year average (17.6), according to FactSet.

In terms of two-day price action following earnings prints, Materials saw the largest upside move with an average gain of 2.1%, followed by Communications and Utilities, which rose an average of 1.5% and 1.4%, respectively. Alternatively, Consumer Discretionary and Technology stocks have seen significant pressure in the two days following their prints, with an average decline of (-2.1%) and (-1.5%) respectively. The remaining sectors saw moves of less than +/- 1.0% in the two days following their reports.

Rates

Fed Policy:

US 2YR Yield:

US 10YR Yields:

US 30YR Yields:

2YR10YR Spread:

Looking Ahead

February will bring the conclusion of the 4Q23 earnings season as well as crucial jobs, inflation, and GDP data. Federal Reserve Chairman Powell emphasized the importance of continued positive data when it comes to the FOMC’s decision regarding when to begin cutting rates, so if the market has any hope of a March cut, the February inflation data really needs to be spectacular. The market seems comfortable with the “goldilocks” scenario of good economic data and lower rates ahead, so accelerated rate cutting driven by a weak economy would likely not be as bullish for stocks. 

Furthermore, we need to continue to watch the potential fallout from the collapse of the Chinese real estate market. China Evergrande, the second-largest property developer in mainland China, is being liquidated, and attention will soon turn to Country Gardens, which has also been under significant pressure. The Hang Seng Index has fallen over 20% since the end of 2022. While the PBOC has stepped in to stem the bleeding, it remains to be seen if there will be knock-on effects across the globe. 

The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. All information contained herein is obtained by Nasdaq from sources believed by Nasdaq to be accurate and reliable. However, all information is provided “as is” without warranty of any kind. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.