January 2023 | Equity Commentary
Published on February 15th, 2023
Market Overview
Stocks and bonds rallied to start the new year, as economic data and inflation continued to trend lower and paved the way for the Federal Reserve to scale down the size of fed funds rate increases. The US jobs market, however, continues to be an asterisk on expectations for further rate increases, as payrolls surprised to the upside in December. We believe too little slack in the labor market has been the proverbial thorn in Fed Chairman Jerome Powell’s side, which led him to reiterate after January’s meeting that inflation will not return to 2% until there is “better balance in the labor market.”1 Stocks declined following the jobs report, but still posted strong returns for the month with the S&P 500 rising 6.3% and the Nasdaq up +10.7%.2 The additional boost for tech stocks may have resulted from investors re-entering positions sold late last year for tax loss harvesting purposes. Bond prices also rose sharply in the month, with the yield on the 10-year US Treasury bond falling from 3.87% at the end of last year to 3.51% by the end of January.3
As we expected, the Federal Reserve raised its benchmark fed funds rate by 25 basis points at the January meeting, to a range of 4.5% – 4.75%.4 The week before the announcement, the Bureau of Economic Analysis reported that the Fed’s preferred inflation gauge – the personal-consumption expenditures (PCE) price index – increased by 5% year-over-year in December, a solid improvement from November’s 5.5% print and also the lightest inflation reading since September 2021. The Core PCE-price index, which measures inflation minus food and energy, rose 4.4%.5
In the Fed’s view, encouraging inflation trends are neutralized by strength in the labor market. In January, employers added 517,000 new jobs, essentially double what most economists had forecast. The four-week moving average of initial jobless claims—which is generally a useful leading indicator for economic weakness—fell to 189,000.6 For context, when the jobs market was considered strong in 2019, claims averaged about 220,000 each month. Job openings also rose to 11 million at the end of last year, which brought the ratio of unemployed workers to job openings back above 2:1.6
Chairman Powell holds the view that unemployment and inflation have an inverse relationship, which is the economic theory known as the Phillips Curve. While his ongoing hawkishness appears to be rooted in this theory, a bright spot for markets is that employment costs and private-sector wage growth have actually come down over the past few months, even as the labor market remains strong and the unemployment rate has fallen.7 For Q4, the Labor Department reported that employers spent 1% more on wages and benefits than they did in Q3, which was an improvement from the previous quarter’s 1.2% pace. On an annualized basis, wages and benefits grew by 4% in the fourth quarter, which is a marked improvement from the peak 5.8% pace set earlier in 2022. 4% wage growth is not compatible with the Fed’s 2% average inflation target, but it’s accurate to say that wage pressures overall have been getting better, not worse.8
The US economy grew by 2.9% (annualized) in the fourth quarter, according to an advanced estimate from the Bureau of Economic Analysis.9 While 2.9% is a relatively strong pace of growth, underlying drivers indicate the economy may be weaker than the headline number suggests. In manufacturing, the December PMI fell by 0.6% from November and remained in contractionary territory (48.4%). Industrial production also fell by 0.7% month-over-month in December, and manufacturing output declined by 1.3% with weakness reported across the sector.10
The US consumer also pulled back on spending in December. For the month, spending on services like rent, utilities, and dining out was flat, but when adjusted for inflation marked the weakest reading in 11 months. Goods spending as measured by retail sales also appears to be turning over, as consumers are confronting shorter runways with pandemic-era savings. According to data released by the Commerce Department, retail sales fell by -1.1% from November to December.11
Overseas, Europe’s economy appears to us to be performing better than most expected. We believe that one key reason for the resilience was the energy crisis that never came to fruition, thanks to a mild winter, energy-conservation efforts, and a shift in sourcing for natural gas. S&P Global’s composite purchasing managers index, which measures activity in services and manufacturing, showed Europe moving from contraction territory (49.3) in December to expansion (50.2) in January. Germany, Europe’s largest and most vital economy, showed strong signs of stabilizing, which prompted the German Economy Ministry to forecast 0.2% growth in 2023.12
China’s economy has seemingly benefited from the end of zero-Covid. In January, China’s nonmanufacturing PMI, which measures key services and manufacturing activity, crossed above 50 (signaling expansion) for the first time since last September – a drastic improvement from December’s 39.4 reading. Manufacturing activity rose above 50 for the first time since August, a marked improvement from December’s 47.0 reading. Consumers also showed strong signs of getting back out and spending, despite a surge of infections. Box-office revenues were the highest on record for a Lunar New Year holiday, and train travel surged back to 83% of 2019 levels.13
Tension between the US and China continues, with the latest episode of the spy balloon drawing ire from US officials. In our view, President Biden and President Xi appear to be intent on managing risk in the short-term, particularly as China focuses on an economic recovery in 2023. Incidents like this one strain bilateral relations, but should not escalate to the point of impacting markets or either country’s economic trajectory. As both countries harden their stance toward the other, trade continues to rise between the two: US imports from China increased by 6.3% year-over-year in 2022, while exports rose by 1.6% year-over-year. Despite tariffs and aired grievances, total trade between the two countries reached a record $690.6 billion in 2022.14
Source
2Bloomberg: SPX Index, CCMP Index January Returns
3Bloomberg: USGG10YR Index Returns
4https://www.federalreserve.gov/newsevents/pressreleases/monetary20230201a.htm
5https://www.bea.gov/news/2023/personal-income-and-outlays-december-2022
6https://www.bea.gov/news/2023/personal-income-and-outlays-december-2022
7https://www.wsj.com/articles/beneath-the-surface-fed-sees-no-letup-in-inflation-pressure-11675293510
9https://www.bea.gov/data/gdp/gross-domestic-product
11https://www.wsj.com/articles/us-economy-retail-sales-december-2022-11673990047
12https://www.nytimes.com/2023/01/31/business/europe-inflation-economy.html
As of January 31st, 2023
