Happy Birthday, Mr. President


George Washington’s birthday, one of eleven permanent holidays established by the US Congress, is celebrated annually on the third Monday of each February. A day of rest is granted to many citizens, and the mood is often cheerful, celebrating the life and legacy of our first president and the man who still graces the front side of the mighty US dollar bill.

Regrettably, the mood around President’s Day in capital markets was gloomy and dull, as February proved to be a turbulent month without a continuation of the January rally that began the year. Throughout the month, a slew of economic data came in at or higher than expectations, casting doubt on the prospect of a near-term recession. Thus, a pivot to reduce interest rates later this year, which is what markets desperately want, does not appear likely. We saw markets struggle to come to terms with the reality that interest rates will likely remain higher for longer, putting pressure on all the major indices. Much of the January gains were wiped out, with the S&P500 and US Aggregate Bond Index losing -2.4% and -2.6%, respectively.

The aforementioned government reports and macro data point to a resilient, still-robust economy. In February, both the retail sales and jobs report, which indicated an extremely tight labor market, came in hot, defying the dual headwinds of higher consumer prices and aggressive Federal Reserve interest rate hikes. This has prompted many pundits to delay or even veto their calls for a 2023 recession, with barely even a mention of the dreaded “R word” taking place in the first half of this year.

On the earnings front, the Q4 season is over and has quickly receded into the rearview mirror. Overall, we note relatively flat earnings growth on a year-over-year basis. While the percentage of S&P 500 companies surpassing expectations was slightly more than 66%, the magnitude of these “beats” was lower than historical averages. This quarter saw S&P earnings beat expectations by 1-2% on average, whereas over prior decades, that number was in the 5-6% range. And while we are still waiting for the final earnings per share number to be published, we conclude that earnings were just “OK” last quarter – nothing to write home about, but nothing to get too fussy over either.

Against a strong economic backdrop and a stable, if underwhelming, earnings environment, it is highly likely that the Federal Reserve will be unable to pause or reverse its interest rate hiking campaign. Combining a strong economy with the declining, yet sticky, inflation numbers, we have the perfect recipe for higher interest rates in the future. Indeed, the beleaguered central bank has already telegraphed that it plans to raise the Federal Funds Rate an additional 50 bps this year. Many economists are now expecting additional hikes on top of that, resulting in a terminal rate as high as 5.5 – 5.75%.

Just two short months into the new year, we have a tale of two opposing narratives. January embraced the soft-landing optimism to launch stock and bond markets into the new year with positive force. That momentum has stalled in February, with the “no landing” scenario being the dominant macro theme of the month. Time will tell which narrative prevails, if either at all, but we take comfort in our long-term focus on strategic asset allocation and a disciplined, unemotional process.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. All indices are unmanaged, and investors cannot invest directly into an index.

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