January 2024 Stonemark Market Commentary

Welcome to the beginning of a new year! January proved to be an exciting time for financial markets, keeping investors engaged after a strong finish to 2023. Despite initial concerns about overbought conditions and stretched positioning, the stock market surprised everyone by soaring to record highs in the early days of January, with the S&P 500 Index leading the way.

This unexpected surge was driven by widespread optimism around a 'soft landing' scenario, supported by the sustained momentum of the 'Magnificent Seven' stocks. A series of data releases highlighted the underlying strength of the US economy, providing a fresh boost to the market. Let's take a closer look at the economic indicators that played a crucial role in shaping the market's movements in January and require our attention and strategic analysis.

The US job market was a major source of economic strength in 2023, thanks to steady hiring and rising wages that helped people cope with high inflation. This trend continued into the new year as employers continued to hire at a solid pace in December, capping off a year of steady gains for a job market that has remained a bright spot in an economy that is slowly cooling.

The latest jobs report for December showed that employers added 216,000 positions during the month, and the unemployment rate remained steady at 3.7%. Throughout 2023, employers added 2.7 million jobs, a decrease from the 4.8 million jobs added in the previous year but still a better figure than in the years leading up to the pandemic. The unemployment rate started the year at 3.4%, matching lows not seen since the late 1960s, and despite inching higher towards the end of the year, remains low. However, job growth was not evenly spread across all business sectors, as most job creation in 2023 took place in the hospitality, healthcare, and government sectors which were disrupted during the pandemic. Looking ahead, policymakers at the Fed expect the jobless rate to rise to 4.1% by the end of the year and wage growth to slow down, leading consumers to pull back on spending and reduce overall demand.

The latest jobs report was accompanied by an increase in wages, which was fortunate considering the rise in prices in December. This serves as a reminder of the ongoing pressure on consumers even though inflation decreased by almost half in 2023. While the December reading showed a decrease from the 6.5% rise at the end of 2022, Americans still paid more for rent, auto insurance, and dental visits compared to the previous month. Prices climbed 0.3% from the previous month, compared to a 0.1% gain in November. The consumer-price index increased 3.4% from the previous year, and core prices, which exclude food and energy items, rose 3.9% from a year earlier.

It is worth noting that the Fed's preferred measure to track inflation is the Personal Consumption Index (PCE), which considers a broader range of consumer goods and services compared to CPI and includes expenditures by households, nonprofit institutions, and the government. In December, the US economy experienced another month of mild inflation as the PCE Index rose 2.6% from the previous year, reaching a level of 5.4%. Core prices, which exclude volatile food and energy costs, rose 2.9% on the year, the smallest year-over-year increase since March 2021. Following the release of this data, investors began to expect that the Fed would cut rates in the spring, possibly in March. This is because core price readings in six of the last seven months have been running at an annualized monthly rate equal to or slightly below the Fed's 2% target. While the Fed typically only cuts interest rates in response to concerns about the economy slowing down or entering a recession, officials have suggested that they will consider cutting rates if inflation continues to decrease.

The Fed will not cut rates in early spring as many investors have hoped due to the incredible resilience of the US economy. The fourth-quarter growth of the US economy exceeded expectations by growing at an annualized rate of 3.3% instead of the predicted 0.2%. The economy expanded by 2.5% in the entire year of 2023. The credit for this better-than-expected growth goes to consumers who continued to spend freely on healthcare, dining out, and cars. Additionally, the growth was supported by increased government spending, particularly at the state and local levels.

On the last day of the month, during the first FOMC meeting of 2024, Chairman Powell delivered guidance that the strong job numbers, tapering inflation data, and robust GDP growth numbers meant that the Fed was not in any hurry to cut rates anytime soon. As a result, the central bank held its benchmark federal funds rate steady in a range between 5.25% and 5.5%. During the televised press conference after the decision, Chairman Powell emphasized that the Fed will only lower rates once it has gained greater confidence that inflation is moving sustainably toward 2%. Powell and Fed officials are trying to balance two risks. One is that they move too slowly to ease policy, and the economy crumples under the weight of higher interest rates, leading to a severe recession. The other is that they ease too much, too soon, allowing inflation to reaccelerate much like it did in the 1970’s. The Fed last hiked rates in July 2023, and officials largely believe it takes at least 12 to 18 months for adjustments to take effect, which means investors should temper their hopes of a cut coming sooner. Since late December, Chairman Powell and several Fed officials have been signaling this, and investors and the markets must pay attention.

Although the stock market is reaching new all-time highs, the possibility of a recession in the US economy cannot be ignored. The Conference Board's Leading Economic Indicators (LEI), a combination of economic indicators such as jobless claims, manufacturing hours, stock prices, and consumer confidence meant to show turning points in the economy, has been showing warning signals since the start of 2022. The LEI fell for the 22nd consecutive month in December, inching down 0.1% to 103.1. This is compared with the expected 0.3% decrease and -0.5% in November, as reported by The Conference Board during the data release. This marks the longest monthly losing streak since the period leading up to the Great Financial Crisis in the spring of 2008, which devastated the economy and the markets.

This is a worrying trend for those who are optimistic about the US economy. Historically, every time the Leading Economic Index (LEI) has been negative for a prolonged period, a recession has hit the US economy. Although the monthly declines have reduced in size, the six-month and twelve-month growth rates of the LEI are still negative. This indicates that there is a risk of an upcoming recession. Justyna Zabinska-La Monica, Senior Manager of Business Cycle Indicators at The Conference Board, predicts that the GDP growth rate will turn negative in the second half of 2024, only to recover later that year.

Looking ahead, February is an important month that will bring the conclusion of the fourth quarter 2023 earnings season, along with crucial jobs, inflation, and GDP data. Federal Reserve Chairman Powell has emphasized the importance of continued positive data for the FOMC's decision regarding when to begin cutting rates. Hence, if the market hopes for an early rate cut, the February inflation data needs to be exceptional. The market seems comfortable with the "goldilocks" scenario of good economic data and lower rates ahead. Therefore, accelerated rate cutting driven by a weak economy would likely be less bullish for stocks.