Highlights:
- The S&P 500 returned 1.7% in January, driven by mega-cap stocks, while the equal-weighted index returned negative (-0.8%), with midcap and small cap stocks suffering more.
- Economic indicators reflected surprising strength in the U.S. economy, with robust GDP growth and job gains, alongside continued consumer confidence and decreasing inflation.
- Federal Reserve Chairman Powell's late-month address eliminated prospects for a much-anticipated March rate cut and tempered expectations for future cuts.
Following extremely strong months for stock and bonds in late 2023, January proved a more moderate month. While the S&P 500 Index's return of 1.7% suggests a solid month for stock investors, the equal-weighted return of the index was negative (-0.8%), while midcap and small cap stocks suffered even more. It was the familiar story of index returns driven by a handful of mega-cap stocks. A sense of the disparities was evident in fourth quarter corporate earnings reports (with about half reporting as of this writing), which have been highly bifurcated by sector. Technology, Consumer Discretionary, Communication Services, and Utilities Sector stocks reported double-digit gains, while Financials, Health Care, Materials, and Energy produced double-digit declines. Mega-cap tech stocks have dominated the aggregate earnings growth. While interest rates showed some volatility during the month, the yield on the bellwether 10-year Treasury ended about where it started, and bond returns were basically flat.
Behind these returns were an array of economic reports and indicators, the bulk of which showed surprising strength in the U.S. economy via GDP growth and job gains. Consumer confidence remained strong behind trailing stock gains and lower gas prices. Meanwhile, inflation measures continued the downward trend, which had produced wide expectations of Federal Reserve easing in 2024, a primary driver of the late 2023 stock rally. The hopes for a series of five or more interest rate cuts gradually faded with each report of economic strength. This was capped by a late-month address by Federal Reserve Chairman Powell that virtually eliminated the prospects for a much-anticipated March cut. He also dampened expectations regarding the number of cuts we could expect this year.
Despite the Fed disappointments, spirits remained high following the strong stock and bond returns in 2023. However, we believe a clear-eyed look at the economy, stock valuations, and yields gives cause for caution. For instance, the GDP growth is concentrated in the service side of the economy, while manufacturing has been in decline for more than a year. The Materials and Energy Sectors are also lagging. The peak Federal Funds rate hit in July of last year, and history shows the effects often take over a year to be fully expressed. Every week, a large number of loans are resetting at much higher rates, a particular strain on small businesses that face higher costs or even financing woes as banks deal with liquidity issues by tightening issuing standards. Recent troubles with a New York regional bank, New York Community Bancorp, sent shivers through the banking sector and reinforced how we may still have to deal with problems imposed by high rates.