Remember, the time of year when the future appears; like a blank sheet of paper, a clean calendar, a new chance…
– Jackie Kay, “Promise”
A pair of headlines on the front page of the January 31st edition of The Wall Street Journal presented interesting contradictions to that day’s news. The Journal’s headline “UPS Sets 12,000 Job Cuts as Slump Drags On” was followed later by an article in Barrons quoting Fed Chairman Jay Powell from that day’s press conference: “He doesn’t expect the labor market or economic growth to slow anytime soon.” A second headline from the Journal, “Microsoft’s Profit Soars 33% as AI Bolsters Cloud Demand,” was succeeded, also in Barrons, by “the reaction from analysts on Wall Street was mostly resounding… market reaction is more muted.” This was perhaps a bit of an understatement, as the stock was down 2.7% on the day. The day had an almost “end of an era” feel about it. Could it be that with the financial markets obsessing over “the magnificent seven” and the timing of Fed rate cuts, both are poised closely in time to when neither will matter very much anymore?
While the month was filled with headlines about the S&P 500 making all-time highs, the overall market’s behavior was less than ebullient. Mid-cap and small-cap stocks were both down for the month, the latter by almost 4%. Six of the S&P’s eleven sectors were also negative, as were eleven of fourteen larger foreign markets. For all the talk of all-time highs in the market, the actual state of reality when viewing markets on a year-over-year basis is a good deal more subdued. Yes, the S&P 500 is +20.6% and the NASDAQ 100 is +42.5%, but mid-cap stocks are +4.7% and small caps +1.8%. The equally weighted version of the S&P 500 is +4.9%, four of eleven S&P sectors are negative, markets outside the US are +4.8%, and the US bond market is +2.1%. For stock market investors, fortunately, help may well be on the way. The Fed has a mandate to keep inflation close to 2% while maintaining employment at near full levels. There are emerging signs that the growth in employment may soon be slowing. Inflation is now very close to 2% and is even, by some measures, below it. So, with the Fed funds rate at 5.5%, the Fed’s own inflation forecast for the year at 2.4%, and a “neutral” rate of interest, one neither contributing to nor subtracting from the rate of economic growth, of 0.50%, that gives us a neutral rate of interest of 2.9%, which is 2.6% below current levels. This is our future, and if the stock market doesn’t yet grasp that, it likely will—and possibly soon.
What is it about the calendar and financial markets? Is there a logical explanation for why entering into a new year should result in a significant change in financial market behavior? If investors don’t recall that it used to be this way, that would be because it wasn’t; but for the last three years, it has been. The S&P 500 was +9.8% in the three months of Q4 2021, with 4.5% of that in December. Stepping into January 2022, the S&P 500 was up on the first day but down on the next five and fourteen of the first twenty, leading to an 8.7% decline by January 27th. An index measuring the performance of technology stocks provided rocket fuel to contrast those returns, rising 14.7% in Q4 2021 before falling 12.9% from the start of 2022 through January 27th. December 2022 marked the end of a tough year in the stock market with the S&P 500 at -16.1% for the year and -5.8% in December, accompanied by mid-cap stocks at -5.5% and small caps at -6.7% that month. Again, we turn the calendar to 2023, and the S&P 500 returns +6.3% for January, mid-cap stocks are +9.2%, and small caps are +9.5%.
Entering January of this year, if one were to wonder whether the turn of the year would also represent a very significant change in the behavior of the stock market, the answer would be yes, with an exclamation mark. The tale is not best told by the performance of the S&P 500, as it was up both before and after the New Year, but rather by the contrast in the relative performance of various markets. A sure-fire bet to win a trivia contest is to provide the correct answer to the question: which index would have provided investors the highest rate of return over the past sixty days, technology or small-cap stocks? The surprising answer is small-cap stocks, up 8.3%, versus technology’s 6.8%. But what makes this so interesting isn’t the fact, but rather the timing. In December, technology stocks returned 3.9%, while small caps returned 12.8%. Looking at a chart of the two indices, one can see the peak of small caps’ outperformance on December 27th, two trading days before the year’s end. The two indices then traded on equal terms for the first three trading sessions of 2024 but later diverged, with technology returning 10.4% through the 24th of January versus small caps’ 0.4%. Here, one is reminded of a quote: “once is an accident, twice is a coincidence, three times is a pattern.” But why?
60% equity, 40% fixed-income portfolios returned 1.5% for the month for reasons investors haven’t experienced in a number of years. Equities were up less than 1%, with large-cap growth’s 2% offsetting the modest negative returns of the majority of equity holdings. Fixed income outperformed equities, returning 4%, with Commercial Mortgage-Backed Securities (CMBS) coming to life due to the improving outlook for interest rates.
Mark H. Tekamp