Equities were up marginally for the week despite falling after reaching record highs. Investors continue to adopt a “risk-on” mentality despite lofty price-to-earnings (P/E) valuations as corporate earnings appear to be generally strong.

The S&P 500 finished up 0.1%, while the NASDAQ rose 0.6%. Small caps rose significantly during the week gaining 2.4%. Treasury yields backed up to three-month highs with bond indices falling 0.9%

At the beginning of 2024, over 90% of the stocks in the S&P 500 were trading above their 50-day moving average. This continued the bullish momentum that had occurred during the last two months of 2023 in a broad-based rally across a large number of sectors and companies.

However, by early February the percent of stocks trading over their 50-day moving average had fallen to 63%, despite the S&P 500 gaining almost 5% in the first six weeks of the year. The market rally was more restricted to a small number of stocks and sectors, echoing the same characteristics of the first 10 months of 2023.

Inflation, as measured by the Consumer Price Index (CPI), came in higher than forecasted in January (3.1% actual versus 2.9% forecasted).

Although January’s CPI was lower than the previous month (3.4%), inflation appears to remain sticky with several categories of goods and services exhibiting relatively high levels of inflation. Shelter costs, auto insurance and recreation continue to show signs of relatively high rates of inflation.

Equity markets sold off following the release of the CPI number as investors perceived persistent inflation puts potential rate cuts by the Federal Reserve for 2024 at risk.

The month of February marks the fourth quarter earnings results season. With two-thirds of the S&P 500 companies having reported fourth quarter earnings thus far this month, approximately 80% of companies have beat analysts’ expectations.

Compared to the fourth quarter of 2022, earnings are expected to grow 9%. This is higher than expectations were at the start of 2024 as results are coming in relatively strong across most sectors.

Calendar-year 2024 earnings growth is forecasted to be 9.7% compared to calendar-year 2023, primarily led by Information Technology and Communication Services companies. The bulk of the forecasted earnings growth is expected to be limited to a small handful of sectors.

During the latest quarterly earnings season there have been several bellwether companies of note across various sectors announcing layoffs in order to cut costs and optimize operating margins.

However, weekly initial jobless claims are down from their two-year highs that peaked in June of 2023 and are currently at the midpoint of the two-year range. This would indicate a rebalancing of a continuing resilient labor market as the unemployment rate is currently at 3.7%, still at the very low end of its historic range.

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• 10-year Treasury yields have historically moved in a similar direction as the Fed Funds.
• The exception is when the bond market is anticipating the last hike or cut (sometimes incorrectly).
• The arrows show where the 10-year Treasury anticipated the eventual peak or trough in the Fed Funds rate.
• The 10-year Treasury peaked at 5% just as the Federal Open Market Committee (FOMC) hiking bias was coming to an end.
• Yields should trend lower as long as the FOMC remains biased to cut rates.

• Corporate bonds have outperformed Treasuries by nearly 100 basis points (bps) per year over the past 50 years.
• Corporate spreads are mean reverting and will cycle from high to low with little time spent at the average.
• Our proprietary strategies increase exposure as spreads widen and reduce when they are low.
• Mortgage-Backed Securities (MBS) total return indices also outperformed Treasuries in the long run.
• Currently, corporate bond spreads are at tight levels and our proprietary strategies are modestly overweight.

• Equity markets rallied in January, continuing their trend from 2023.
• Growth stocks were the best performing group across all market caps.
• Small caps continue to underperform versus large caps, continuing a trend that was present during 2023.
• Investors continue to adopt a “risk-on” mentality despite relatively lofty price-to-earnings (P/E) valuations as expectations for earnings growth remain high.

• Manufacturing activity in the United States as measured by the Manufacturing Purchasing Managers’ Index climbed to 50.3 in January (a reading over 50 indicates expansion, whereas below 50 indicates contraction in activity).
• The latest results marked the first time manufacturing activity was in expansion mode since October 2022.
• Companies are continuing the trend of “onshoring” their production and bringing manufacturing activity back to the United States.
• While manufacturing constitutes less of the overall economy than it did previously, it is still an important part of the United States Gross Domestic Product (GDP) and is aiding in the generation of steady economic growth.

• January’s Nonfarm Payroll release showed 353,000 new positions were added during the month. This was the highest number in two years, topping expectations of 175,000 and besting December 2023’s figure of 330,000, which was revised upward.
• The unemployment rate remained unchanged at 3.7%. The participation rate was also unchanged at 62.5%.
• The healthcare and retail sectors saw the largest number of new positions created.
• Wage growth and hourly earnings also kept pace, signaling the Federal Reserve may not move quickly to lower rates.

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Stocks continued their year-to-date advance but lost a bit of steam after the S&P 500 Index came remarkably close to hitting the 5,000 level for the first time. Year-to-date this market’s weighted benchmark is up 4.1% led by firms in the semiconductor, internet media and streaming service providers.

Longer-dated bonds underperformed with the Treasury getting ready to issue more debt after this week’s successful auctions which were at record levels.

This week saw reports of stronger economic data including reports on unemployment and ISM data that suggest employers are still holding onto their workers and the economy remains resilient.

Headline nonfarm payrolls increased by 353,000 in December and the unemployment rate held steady at 3.7% for a third consecutive month. Even the revisions of previous reports showed the second half of 2023 was hotter than was apparent in real time.

This suggests that upward pressure on wage growth will persist and has removed the likelihood of a Fed rate cut this quarter.

The headline ISM Manufacturing PMI, a measure of U.S. factory activity, increased to 49.1 in January from 47.1 but remains in contractionary territory. This jump appears to have come from firms placing new orders to replace inventory that had been declining over previous months. Still, manufacturers remain cautious as only four of 13 industries reported growth in January.

Improvement in the month’s ISM Services activity gauge aligned with the strong payroll report, reflecting stabilization in the services sector, however, parts of the report remain mixed. The index beat estimates as it rose to 53.4 in January versus a consensus expectation of 50.5. This reading reversed the declines that were seen in the prior two months. Like the improved orders seen on factory floors, backlogs of new orders helped advance this measure as firms met the added demand through additional output instead of using inventories. Survey participants noted rising transportation costs and scheduling issues due to “unrest in the Red Sea” for pushing costs higher.

Hawkish remarks from Fed Chair Powell noted here last week were affirmed by the strong economic data this week, effectively taking a March cut of the Fed Funds Rate off the table. Now, May has become the earliest date for the next Fed rate move. Bond markets responded to an outlook where interest rates stay higher for longer by pushing the U.S. Treasury 10-year yield from 3.88% to 4.12%. This sent broader bond market returns down by 1.41% pushing the year-to-date results into negative territory.

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Equities finished the week down amid hawkish remarks from Fed Chair Powell. The S&P 500 suffered its worst single-day drop since last October, but gains earlier in the week helped limit the damage.

The weekly decline was just 0.5%. The NASDAQ was down 2% as earnings reports from Big Tech sent shares down in select names. Bond yields rallied and returned 1.3% on the week.

The first month of the year is in the books, and small caps remain weak with a more than 5.5% gap to the S&P 500. The S&P 500 posted a monthly gain of 1.7%, but the average stock was down.

Seven out of 11 sectors were down and each more than 1%. Real Estate lagged with a loss of 4.8%, whereas Communications led with a gain of 3.1%. The star of 2023, NVIDIA, put in the second-best performance in the S&P 500 with a monthly gain of 24%. Fellow Mag-7 member Tesla was the worst performer in the Index with a decline of 24%.

It is now at risk of being relegated as pundits scramble for a new acronym to include more red-hot semiconductor names.

The Federal Open Market Committee (FOMC) left interest rates unchanged at 5.5% for the fourth-straight meeting. They removed the line about additional policy firming, making it official that the peak rate is in for the time being.

Fed Chair Powell, in a rare explicit statement, said that a March rate cut was not the base case. The market did not like this, and equities proceeded to go straight down following this statement.

Powell said they need more confidence that inflation would hit their target despite being pleased with recent data developments. It is clear the Fed will be cutting this year, and it’s likely they just wanted to cool animal spirits a bit given the huge easing in financial conditions following the market’s recent rally.

Markets are rallying today, and maybe they have come to realize that a short delay in cutting the Fed funds isn’t material if the bias is to cut multiple times this year.

It would likely take an inflation scare to change the narrative and dent equity prices. But inflation has easy comps in the next couple of months and it is unlikely to show a material acceleration. The rest of the week will still bring some Big Tech earnings, as well as the unemployment report, but markets tend to fare well for a couple of weeks when these event risks come and go.

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After a negative performance last week, equities retuned to the plus side in a meaningful way this week. The Russell 3000 Index of domestic stocks returned 2.1% for the period. The growth component of the index, the Russell 1000 Growth Index, was even more impressive with a return of 3.3%.

Helping to propel stocks higher were last year’s two best performing sectors: Information Technology and Communication Services. The leadership of these two sectors is also seen in the year-to-date differential between growth and value indices.

The Russell 1000 Growth Index has returned 4.0% year-to-date, while the Russell 1000 Value Index is trailing with a return of -0.7%. Other market segments also moved higher for the week but at a more modest pace. Small cap stocks advanced 1.8% and developed markets outside the United States had an identical return, also registering 1.8%.

Unlike the equity markets, the bond market did not produce a positive return for the week as it generated a total return of -0.4%. The negative return was attributable to the increase in interest rates that occurred over the period as the yield on the 10-year U.S. Treasury moved from 4.10% to 4.18%.

The economic calendar was relatively light this week but was not without significance. Housing related data was one of the prominent areas represented in this week’s data, with housing starts and building permits both producing better than expected results.

Housing starts actually declined month-over-month, but the decrease was less than forecast and the seasonally adjusted annualized rate for the metric was higher. On the negative side, existing home sales were slightly behind the results anticipated by economists.

While the housing data was somewhat mixed, the consumer continued to show strength as the University of Michigan Consumer Sentiment Index registered a much stronger than expected preliminary reading of 78.8.

This compares to the forecast of 69.5 and a prior reading of 69.7. The index is now at its highest level since July 2021 and the two-month move is the largest since 1991. Increased confidence that inflation is moderating was a driver of the strong reading, as well as recent gains in the stock market.

Other significant economic data points for the week were the preliminary readings for the Markit PMI series.

All three metrics (composite, manufacturing and services) had readings over the 50.0 threshold, which suggests economic growth. Most significant was the result for the manufacturing sector, which was forecast to deliver a reading of 47.8 but delivered a meaningfully stronger result of 50.3.

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Throughout 2023 we repeatedly used the term “resilient” to describe the U.S. economy. The most readily visible evidence of this resilience was seen in quarterly GDP results.

As we progressed through the first three quarters of the year, the results were consistently higher than anticipated. The third quarter represented the strongest of the year’s first three quarters registering growth of 4.9%. The key variable contributing to the robust growth was a firm employment environment. This environment was characterized by continued low unemployment, ample job openings, and meaningful wage growth.

This combination translated into consumers that had secure incomes and with those incomes an ability to purchase goods and services. Given the significant role consumption plays in the U.S. economy, the rate of growth becomes more robust when the consumer has the capacity to buy goods and services. Not surprisingly, the biggest contributor to the economy’s third quarter growth was consumer spending.

While the term “resilient” is still appropriate in describing the economy it needs to be acknowledged that the resilience is beginning to wane.

Forecasted GDP growth for the fourth quarter is expected to register a much more tepid reading of 1.0% according to FactSet. The Federal Reserve Bank of Atlanta’s GDPNow estimate of fourth quarter growth currently sits at 2.0%, representing a rate of growth that is less than half the third quarter’s actual result of 4.9%.

The tepid growth is currently projected to continue into 2024 as GDP is expected to generate growth of only 0.6% for the first quarter according to FactSet.

Although the words tepid and waning may be appropriate adjectives to use to describe economic growth going forward, they do not necessarily translate into negative growth or recession.

Our current base case, as discussed in our recent Economic Themes publication, is that we will see positive but lower growth as we move into 2024.

Some of the variables that are expected to contribute to ongoing positive growth is a labor market that bends but does not break, a Federal Reserve that implements multiple reductions in the Fed Funds rate and relative stability in key industries such as housing and auto production.

Regarding the key industries referenced above, according to Cox Automotive, auto production in 2024 is forecast to reach a level of 15.6 million.

While this level represents only a slight change compared to 2023 production it does represent the aforementioned stability. Housing delivered some interesting results over the past year.

Existing home sales experienced a precipitous drop, while new home sales remained relatively steady, with the result for November registering an annualized rate of 590,000 compared to the November 2022 report of 582,000 units. The decline in existing homes sales, from an annualized level of 4.6 million in February to a level of 3.8 million in November, was attributed to the reluctance of homeowners to relinquish low-rate mortgages locked in, at, or near the trough in mortgage rates.

Results are expected to improve on both the existing and new home fronts in 2024 as mortgage rates ease and new supply comes to market.

Also lending support to further economic growth are consumer sentiment surveys that have recently registered higher than forecast readings indicating a growing level of confidence.

Financial markets reversed course in the fourth quarter with both equity and fixed income markets providing very strong returns for the period. The strength was more than enough to offset the negative performance from both asset classes in the third quarter.

Given the turnaround in asset class returns each of our seven allocations generated positive results for the quarter. Not only that, but each also generated a meaningful return for the entire year. Excluding the two most conservative allocations, double-digit performance was realized across the board for 2023.

With its three-month return of 12.1% the Russell 3000 Index of domestic equities achieved its best quarterly performance since the final three months of 2020.

The annual return of 26.0% was the highest since the 31.0% that was generated in 2019. Fixed income’s return of 5.5% was solidly positive and allowed bonds to avoid a third consecutive year of negative performance.

Throughout the fourth quarter we maintained our neutral positioning across each of our seven investment objectives. In fact, we actually maintained the neutral state for the entire year.

This static strategy worked quite well in 2023 and was in alignment with the tenets of our investment philosophy which includes a long-term view of the financial markets. As the year progressed, we saw significant gyrations in both the equity and fixed income markets.

Over the course of the year’s first three quarters, bonds were negative in terms of year-to-date performance. At various points in time small cap and foreign equities were both being touted as emerging leaders of the stock market. By the end of the year, however, bonds had migrated to a meaningfully positive annual return and large cap domestic stocks had totally dominated the other segments of the equity market.

Given our economic, equity and fixed income outlooks we begin the new year with our neutral allocation stance still in place. As always, we will be consistently monitoring economic data and developments across the financial markets to determine if a move away from neutral is warranted.

In conclusion, we encourage investors to review their current investment objective and evaluate its level of appropriateness given their goals and level of risk tolerance.

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Equities finished the week down 0.9%, but there was weakness in some higher beta industries. Small caps lagged with a 2.9% drop and have started to give back a good chunk of their December outperformance.

Small caps outpaced the S&P 500 by more than 10% over a two-month span into the last week of 2023. Since then, they have lagged by 6.5% in just over two weeks.

Core bonds were down 0.3% on the week and extended the slow start to the year. The year-to-date return is down 1.2% with the 10-year Treasury higher by about 25 basis points.

Yields pushed higher and equities dipped as Fed official Waller noted that when the Fed begins to cut, they will need to be methodical and careful.

It was his dovish comments in November that helped spark the equity and fixed income rally, so his words carried a little more weight. Fed officials continue to push back against the six market-implied cuts for 2024.

The odds of a cut in March sit at 56%.

Economic data continues to exceed expectations. The highlight this week was a consumer that pushed retail sales well above expectations. The retail control group, which backs out auto, housing, tobacco and a few one-offs, rose 0.8% in December. This easily outpaced the estimate of 0.2%.

The Atlanta Fed GDPNow is up to 2.4% for the current quarter and again starting to exceed the highest economist forecast. Jobless claims continue to be the glaring hole in the recession thesis. Today the number came in at 187,000, which is the lowest reading in over a year. Offsetting this somewhat continues to be the relatively weak manufacturing readings.

The Core CPI for December was up 0.3% versus the prior month and ticked up to 3.9% year-over-year. Non-housing service inflation, known as the “supercore,” was up 0.4% for two consecutive months.

This annualizes to 5%, which is well above 2%, and it is accelerating now. In July, the four-month annualized rate of change was about 1.6%, but it is now up to 5.1% after the latest reading. This acceleration has mostly been ignored as lagged housing readings push down the overall core number.

Next week we start to see the big central banks make their monetary policy decisions. In two weeks, the Fed will go last. There is a calmer feeling from participants as we head into these weeks versus last year.

The big risks have failed to materialize. However, it is when expectations are low that modest surprises have a much larger ripple effect on markets.

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Over this past week, U.S. equities advanced 1.7%, while foreign equities rose 0.3%. Bonds declined 0.5% over the week, which reflected the near-term trend in yields. According to FactSet, the yield for the U.S. 10-year Treasury retraced to 4.0% from 3.9% a week ago.

Markit, an S&P Global company, released its final Purchasing Managers’ Index (PMI) Services survey for December 2023. According to Markit, December posted a reading of 51.4, which was in line with expectations (note a reading above 50 indicates expansion; a reading below 50 indicates contraction).

Markit reported services “… signaled a quicker expansion in activity at the end of 2023,” driven by stronger demand and a rise in new orders, which enhanced overall confidence by business managers.

Markit’s broader PMI sector measure, which considers both U.S. manufacturing and services, exhibited the lowest report since January 2023, as only two of seven sectors measured registered increases during December.

Health care displayed the best expansion since April 2023. Financials, driven by an increase in overall business activity, exhibited the quickest upturn since April 2022.

The employment situation remained unchanged for December. According to the Bureau of Labor Statistics (BLS), the unemployment rate remained at 3.7%, while non‑farm payrolls increased by 216,000, exceeding consensus estimates of 160,000. BLS reported continued increases in government, health care, social assistance and construction.

Job losses occurred in both transportation and warehousing. Additionally, average hourly earnings for private non‑farm employees payrolls rose 0.4% in December. For calendar year 2023, average hourly earnings increased by 4.1%.

The ability for sustained spending by the consumer, which accounts for approximately 68% of U.S. GDP, remains front‑of‑mind to most investors.

Consumer credit expanded by $23.8 billion during November, as reported by the Federal Reserve earlier this week. This materially exceeded consensus expectations of $9.0 billion and October’s print of $5.8 billion.

The National Federation of Small Business released its Optimism Index for December. While the index increased 1.3 points (to 91.9), December marks the 24th consecutive month below the index’s 50-year average of 98. Inflation replaced labor quality as the primary concern of small business owners.

Companies have begun reporting 4th quarter 2023 earnings. Banks will be the focus this week as J.P. Morgan, Bank of America, Citigroup, Bank of New York Mellon and Wells Fargo will release their earnings reports on Friday.

According to FactSet, approximately 75% of S&P 500 companies will report through month‑end. Stay tuned.

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Equities finished lower for the week due to a “risk-off” mentality in the markets, reversing the trend from the prior week. The S&P 500 finished down 1.6%, while the Nasdaq was down 3.4%.

Small caps experienced a more significant sell-off, falling 4.5%. Treasury yields backed up during the week, off of their five-month lows, with bond indices falling 0.9%. The Magnificent 7, which has dominated stock market headlines for the better part of a year, underperformed the broader markets.

Investors are anticipating a “soft landing” with regards to the Federal Reserve’s policies. In their December meeting, Federal Reserve officials viewed the policy rate as likely at or near its peak for this tightening cycle.

They stated a lower target range for rates would be appropriate by the end of 2024, citing declining inflation rates and a more robust supply chain. However, there remains uncertainty as to the timing of rate cuts during the year.

IHS Markit released its final Manufacturing Index Report for December, coming in slightly lower than expected at 47.9 (a value under 50 indicates a contraction in activity, whereas a value over 50 indicates expansion).

The Manufacturing Index has been at or below 50 for 15 consecutive months. However, manufacturing is a significantly lower proportion of the economy versus the services segment of the economy, which continued to exhibit strength for most of 2023.

The JOLTS job openings for November came in higher than expected. Although the figure was at its lowest level since April 2020, it is still well above its 10-year average as the labor market continues to exhibit consistent strength, despite continued, though muted, fears of an upcoming recession.

Later this week, the non-farm payrolls and unemployment rate for December will be released, and undoubtedly investors will be watching these figures to see if there are any signs of weakness in a generally strong labor market.

Investors are generally upbeat regarding their view on the equity markets following a very strong 2023.

The AAII U.S. Investor Sentiment Index measures the difference between the percent of investors who are currently bullish on the market versus the percent of investors who are bearish on the market. The Index is currently at the high end of its 10-year range indicating there is much optimism regarding the stock market.

There are however lingering fears regarding a potential recession as economists have recently noted an increased movement in negative economic growth indicators, which may lead to instability in corporate and personal spending, as well as cutbacks in the labor market.

It is important to note that many predictive economic leading indicators have been incorrect since 2020 given the extreme and unprecedented events that transpired during and after the pandemic.

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