Authored by :
Michael G. Dow, CAIA, CFA, CPA, Chief Investment Officer
Julien R. Frazzo, Director of Risk Management and Securities Research
* * *
The Quick Facts
- The S&P 500 posts its best performance since 2019 with a January gain of 6.3%, while the Nasdaq posts its best January since 2001 with 10.7%
- International equities outperform the U.S., boosted by a weakening U.S. dollar and China’s reopening
- Corporate earnings show lackluster growth
- The Federal Reserve (Fed) hiked rates another 25 basis points on February 1
- December’s headline Consumer Price Index (CPI) declines for the month, in line with market expectations
The stock market finished the first month of 2023 with healthy gains despite widespread concern that the economy might be on the brink of a recession. After a rollercoaster 2022 and despite mixed earnings results, January offered a strong start to 2023, characterized by better-than-expected GDP growth, a slowing pace of inflation, and expectations of reduced rate hikes by the Fed, with the S&P 500 up 6.3%, posting its best January performance since 2019.
The tech-heavy Nasdaq Composite index posted its best January performance since 2001. After falling 32.5% in 2022, the index rebounded to start the year with a 10.7% gain. International equities outperformed the U.S., boosted by a weakening U.S. dollar and China’s reopening. In a sharp reversal from last year, most S&P 500 sectors posted gains, with Consumer Discretionary in the lead (+15.1%). High Beta led among U.S. equity factors, while Low Volatility and Momentum lagged.
One key factor to the January rally was optimistic investor sentiment that the Fed could pull off a soft-landing scenario as opposed to a recession, based on moderating inflation data. Other factors included a softening of the U.S. dollar, the reopening of the Chinese economy, the easing of supply chain restraints, and declining energy prices.
Signs of persistent labor tightness encouraged the Fed to raise its policy rate by 25 basis points on February 1. There were 1.9 job openings for every unemployed person in December, the Labor Department’s monthly Job Openings and Labor Turnover Survey, or JOLTS report, showed.
January Asset Class Performance
According to FactSet, with about one-third of S&P 500 companies reporting, 69% have reported actual EPS above estimates, which is below the 5-year average of 77%. In aggregate, companies are reporting earnings that are 1.5% above estimates, which is also below the 5-year average of 8.6%. So far, the 4Q earnings season for the S&P 500 has been subpar. Looking ahead, analysts expect earnings declines for the first half of 2023, earnings growth for the second half of 2023, resulting in 3.4% earnings growth for the 2023 calendar year.
On a total return basis, only three of eleven GICS (Global Industry Classification Standard) sectors finished in the red in January (Consumer Staples, Health Care, and Utilities). The growth-heavy Consumer Discretionary and Communication Services were the leaders, posting positive returns of 15.1% and 14.8%, respectively.
The Russell 1000 Value was up 5.2% in January, underperforming the Russell 1000 Growth by 3.1%. Despite the short-term January reversal, the outperformance of Value over Growth remains a major longer-term investment theme in an environment where long-dated cashflows are discounted at higher rates. The ESG segment of the market, as measured by the MSCI USA ESG Select Index, was up 6.4% in January, in line with the S&P 500. Over the last three years, the ESG index is up 36.8% and approximately 4.2% ahead of the S&P 500 on a total return basis.
The Federal Open Market Committee (FOMC) increased the federal funds rate by 25 basis points on February 1, setting the benchmark target range to 4.5%-4.75%. The smaller move followed a half-point increase in December and four jumbo-sized 75 basis-point hikes prior to that, making this the eighth rate hike in a row. The Fed slowed its drive to rein in inflation and said further interest-rate hikes are in store as officials debate when to end their most aggressive tightening of credit in four decades. The post-meeting statement noted that inflation “has eased somewhat but remains elevated,” a tweak on previous language. The latest 25 basis-point hike is expected to be followed by one more 25 basis-point hike in March, which may bring an end to the current Fed rate hike cycle. The market expects a “terminal rate” of about 5.0% and is pricing in an actual rate cut or two by the end of January 2024. Barring a more painful than expected recession, this seems optimistic.
The yield on the benchmark U.S. 10-year Treasury closed January at 3.51%, below the October peak of 4.24%. The 30-year yield has stayed below 4.0% since mid-November and now sits at 3.63%. Yield on the shorter-term 2-year faded over the month as equity markets have posted a big run and now yields 4.20%. The yield curve remains inverted, with the U.S. 2-year treasuries yielding 69 basis points more than 10-year maturities.
Oil prices as measured by the WTI Crude Oil $/bbl. declined seven of the last eight months. In January, prices declined 1.7% but increased nearly 8% from the early January lows. WTI traded as high as $123.70 back in March, a 14-year high. Gold spot price continued its surge higher for three consecutive months and closed January up 5.7%. Cryptocurrencies also caught a bid in January, with Bitcoin and Ethereum up 38.8% and 31.5%, respectively. The U.S. dollar ticked lower for a fourth consecutive month on the expectation that the Fed will slow the rate of interest rate hikes as inflation pressures ease. The U.S. Dollar Index (DXY) declined 1.4% in January and is down more than 10% from the September peak.
Volatility subsided into month’s end as the market and the Fed are starting to align on the future trajectory of interest rates. The CBOE Volatility Index (or VIX), also known as the fear gauge, saw an intraday high of 23.76 on January 3 before ending the month at 19.4. While equity investors look to the VIX index as a measure of volatility, bond investors focus on the ICE BofA MOVE (MOVE) Index, which measures bond market volatility. The MOVE Index more than doubled last year to as high as 161 but closed at 100 at the end of January, approximately two-thirds of the way back to its 10-year average level of ~ 70.
Chart of the Month – International Equities
Approximately 96% of the world’s population, 84% of the world’s economic activity, and 66% of public companies with market capitalizations greater than $5 billion are outside the U.S. – yet most U.S. investors are under-invested in international companies.
Periods of U.S./International performance dominance tend to run in long cycles. The last ten years of U.S. performance dominance followed a similarly long period of International dominance in the prior ten years. International’s relative underperformance is at historical extremes in both duration and magnitude.
We believe allocations to non-U.S. equities are necessary to capture the entire global equity opportunity set and improve the efficiency of portfolios. Valuations continue to favor non-U.S. equities over a longer-term horizon. The economic outlook in Europe remains uncertain, but further expected depreciation in the U.S. Dollar exchange rate, combined with historical cheap valuations, point to continued outperformance of International equities in 2023.
Higher interest rates continue to support a rotation out of U.S. Large Cap Growth stocks and into U.S. Large Cap Value and Non-U.S. equities.
Quote of the Month
“The four most dangerous words in investing are, it’s different this time.” — Sir John Templeton
Major Asset Class Dashboard
Important Disclosure: This report is for informational purposes only. Opinions expressed herein are subject to change without notice. Beacon Pointe has exercised all reasonable professional care in preparing this information. The information has been obtained from sources we believe to be reliable; however, Beacon Pointe has not independently verified, or attested to, the accuracy or authenticity of the information. Nothing contained herein should be construed or relied upon as investment, legal or tax advice. All investments involve risks, including the loss of principal. Investors should consult with their financial professional before making any investment decisions. Past performance is not a guarantee of future results.
© Beacon Pointe Advisors. All Rights Reserved.