This blog serves as a follow up to our previously released Q4 Investment Themes, as well as an update on what we are seeing and our current outlook.

Here are the top three things we are covering in this month’s blog:

  1. The stock market rallied sharply in January as traders anticipated a Fed Pivot sooner than the Fed anticipates a Fed pivot.
  2. The market cherry picked inflation data and ignored some employment data and earnings data to justify the buying spree. 
  3. Gas prices rose steadily in January while oil reserves remain at very low levels. Any impact to the supply could create a spike in pricing.

Market

The Fed Pivot dominated investor sentiment in January.  The SPX finished up 6.18% for the month.

The Nasdaq and Big Tech is where Fed Pivot Bulls expressed themselves the most.  The Nasdaq finished up 10.68% for the month. The Dow Jones lagged the SPX as traders focused their money on speculating and chasing rather than on blue chips and safety.  The Dow finished up 4.17% for the month. Small Caps (the Russell 2000 or RUT) outperformed as hedge funds frantically covered shorts and flipped back to risk-on mode.  The RUT finished up 9.69% for the month. [1]

The World Index (MSCI) outperformed the SPX with a lot of help from Chinese stocks.  The “China reopens from Covid shutdowns” created a strong bid for stocks in that region.  The MSCI finished up 7.00% for the month.[2]

The Commodity Index (DBC) traded in a sideways range for the month.  However, sideways isn’t a good thing for consumers because it pumps the brakes a bit on the “inflation is still trending down” narrative.  The DBC finished down 0.89% for the month.[3]

Gold traded up all month long as investors reacted bullishly to the drop in real interest rates, and also sought out precious metals as a hedge against the big ramp up in stocks.  Gold finished up 6.52% for the month.[4]

Longer term interest rates (as measured by the Ten-year Treasury or TNX) were down on the month as both recession fears and hopes of a Fed pivot brought out the bond bulls.  The Ten-year yield (TNX) finished the month at 3.52%, down from 3.88% at the end December.[5]

Economy

In early February, many were expecting the Fed to pivot as we were starting to see negative economic data as well as a decrease in inflation. There was a more dovish commentary compared to what had been said recently which caused the markets to race higher for a couple of days.  We think people are anticipating the Fed is going to have to slow down. When you think about it, if the Fed is having to pause the rate in which they’re increasing rates or maybe even pause rate increases overall. The reason they’re doing that is because they’re starting to see challenging economic data come through, which isn’t good for the economy. People who are counting on this Fed pivot are hoping they can slow down the pace or even start to lower rates fast enough to avoid a hard landing and really create the soft landing that people have been talking about since they started raising rates.[6]

On Friday February 3rd, we got the jobs report which was a massive surprise to the upside of more jobs being created. One of the main areas that the Fed is watching in terms of whether their policy is working is the labor market. We continue to see an extremely tight labor market with over a half a million new jobs created in January. The expectation was around 185,000 jobs so a big upside miss on the expectations.[7] We saw the market react negatively to that news possibly believing that this pivot really isn’t in the cards if the labor market continues to be as strong as we’re seeing.[8]

With some of the other indicators, we’re starting to see the data come out over the last couple of months that’s mixed. While we are seeing very strong hiring, we are starting to see the slowing of the rate of growth of wages. [9]We also saw the price of gas begin to move back up again in January. It is increasing at a bit of a faster pace than we saw at the beginning of last year. [10] While looking at oil, we’ve now seen the Strategic Petroleum Reserve has been reduced significantly over the last 6 to 9 months in reaction to higher oil prices. And while that’s helped reduce the overall price of oil in that time, it’s putting the stock of reserves at very low levels. We don’t anticipate seeing this drop in the supply continue which means we are likely to see less supply on the market, which then could impact prices.[11] While we did see initially a drop in oil prices in January, throughout the rest of the month, we saw a relatively steady increase and finished the month slightly above where we started. While overall inflation is seemingly slowly coming down there is a risk that if we all of a sudden have some supply issues with oil or gas, we could see some spikes in prices in those in the coming months.[12]

Overall earnings are another economic indicator we’re keeping a close eye on, which can sometimes be a lagging indicator. We do expect to see continued decreases in overall earnings or negative earnings here in the first quarter of 2023, as well as the second the second quarter of 2023. For companies who have reported their earnings so far in January, we have seen an overall negative trend on earnings and even lower guidance going forward. However, because of the Fed pivot or the potential for the Fed pivot, this seems has mostly been ignored by the market.[13]

Looking at where we see things headed with inflation, we see that inflation will come down in the coming quarters and we expect that Q1 inflation will be closer to 6%. By the time we get to the end of Q2, we anticipate seeing inflation in the low fours, but we are still expecting to see inflation remain sticky. Even with a low 4% year over year inflation, that still creates challenges in the overall economy and is higher than we’ve experienced in recent years. Something to keep an eye on is if there is a spike in commodity prices, which can occur when people believe the Fed will pivot. This could cause inflation projections to creep back up again.[14]

The last area of concern that we want to keep an eye on is GDP. As we look to the quarters ahead, we’re expecting to see negative quarter over quarter growth in the economy. Historically, when you have falling inflation along with falling growth in GDP, we’ve typically seen this as an environment that is not good for equities. Again, there’s always mitigating circumstances and exceptions to the rule, but historically, that’s what we’ve seen. [15]

If the economic data begin to turn more positive and the Fed remains steadfast in the fact that they may not continue to raise rates, then we’re likely to see equities bounce significantly in the first half of the year. However, if we see continued strong jobs data and we start to see inflation creep back up again, the likelihood is the Fed will have to either continue raising rates or at least commit to holding them steady for a much longer period of time, which could create a lot more downside volatility.

Summary

  1. The stock market rallied sharply in January as traders anticipated a Fed Pivot sooner than the Fed anticipates a Fed pivot.
  2. The market cherry picked inflation data and ignored some employment data and earnings data to justify the buying spree. 
  3. Gas prices rose steadily in January while oil reserves remain at very low levels. Any impact to the supply could create a spike in pricing.

We hope you have enjoyed getting a deeper look into our investment research and look forward to providing this to you each quarter going forward. Thank you from the entire Konvergent Team!


[1] Slide 3 – Major Indexes
[2] Slide 4 – Global vs Emerging Market Equities
[3] Slide 5 – Commodities
[4] Slide 6 – Precious Metals
[5] Slide 8 – 10 Year Treasury Rate
[6] Slide 10 – Fed Speech 2/1
[7] https://www.usatoday.com/story/money/economy/2023/02/03/january-jobs-report-today-unemployment-rate/11170452002/
[8] Slide 11 – Tightening Labor Market
[9] Slide 12 – Declining Wage Growth
[10] Slide 13 – Rising Gas Prices
[11] Slide 14 – Holiday Decrease of Reserves
[12] Slide 15 – WTI Oil Price Change
[13] Slide 16 – S&P 500 YoY Growth
[14] Slide 17 – Consumer Price Index
[15] Slide 18 – GDP QoQ