New Year Energy

After a strong rally to conclude 2023, the new year rang in with a more cautious tone as small caps slid and large caps led. Stocks have now rallied for the third straight month, marking the longest streak since August 2021. Unlike the last two months, which saw positive returns for both stocks and bonds, this January provided performance dispersion across asset classes, as treasuries experienced weakness with interest rate cuts taking center stage. Small caps also struggled, lagging their large cap brethren and losing nearly 4% of value during the month. Still, strength was seen across the broad indices, with the S&P500 notching a gain of 1.7% and large cap growth names gaining 2.5%. Party on, Wayne.

Mega-cap tech names, to include the vaunted “Magnificent 7,” continued to drive positive performance. Microsoft, a card-carrying member of the Mag7, eclipsed the $3T market capitalization level just as the NASDAQ and S&P500 were making new all-time highs[1]. Despite weakness to begin the month, the overall market direction was higher as the soft-landing scenario was supported by stronger than expected GDP and retail sales numbers which show consumers continuing to defy expectations and spend, spend, spend. This backdrop should support ongoing strength for equities as we move into February.

The treasury yield curve steepened during the month, resulting in modest weakness in the fixed income space. The 10Y treasury yield was essentially flat, but 30Y yields rose as high as 4.4% before pulling back slightly. Broadly speaking, treasury yields behaved as expected after the Federal Reserve left rates unchanged at its January meeting. While the central bank left some options open, it threw cold water on the possibility of a March rate cut, expressing caution about such cuts until there’s more confidence that inflation is moving sustainably toward that magic 2% number. As of this writing, the target rate remains in the 5.25-5.5% range and futures markets are pricing in just a 35% of a March cut. Not great odds for treasury bulls.

Meanwhile, in the “real economy,” both hard and soft data continue to come in strong. The preliminary reading of Q423 GDP was 3.3% annualized, reflecting healthy vigor in the overall economy. The GDP number was driven primarily by personal consumption (contributing 1.9%) and government spending (contributing 0.6%). For the full year, GDP grew by 2.5%, well exceeding expectations. At the same time, the labor market added 3.5M jobs for the full year, resulting in a generationally low unemployment rate of 3.7%. Strong to quite strong.

The one outlier in this slew of bullish data was inflation. The year-over-year pace of inflation ramped up again in December but remains solidly in the 3-4% range that we have observed since May of last year. The reluctantly strong shelter index contributed the most to higher prices, even while core CPI (which strips out select items such as food and energy) eased down to a 3.9% annual pace. Subsequent reports reinforced flat core prices.

Lastly, we did see geopolitical risk increase during the month, as attacks against shipping in the Red Sea by the Houthis are having a dramatic impact on logistics. The implications for global trade and supply chains could be devastating, especially for select areas already reeling from several wars and drought conditions in places like the Panama Canal. Oil prices, as we would presume, rose during January to log their first gain in four months. And while geopolitical factors have failed to materially affect the capital markets in recent years, they remain a wildcard and could easily escalate, along with domestic political uncertainty as the US presidential campaign gears up.