- US equity indices finished mostly lower over the short holiday week, despite a strong rally in Friday’s session for major averages. The worst performing sectors in 2022 continued their strong run to start 2023 led by Communication services, Consumer Discretionary and Technology.
- Despite a number of headwinds including poor economic data, fears of a recession and a tepid start to earnings season, a peek behind the actual headlines shows that rotation into cyclicals may be underway as investors start to price in a potential economic recovery in 2024.
- Overall and core retail real sales fell sharply in December -0.69% and -1.10% respectively with very few bright spots to be found as the economic data begins to signal a slow down.
- Last week 26 S&P 500 constituents reported failing to meet expectations, with the blended earnings decline for the quarter standing at 4.6%, lower than the 3.9% decline expected at the beginning of the quarter.
- 3 of the largest companies began cutting jobs on Wednesday with Amazon, Microsoft and Google all shedding portions of their workforce, targeting about 42,000 employees globally.
- People’s Bank of China (PBOC) maintained the five-year lending rates at 4.3% and the 1-year loan prime at 3.65% for the fifth consecutive month. Economists expect rates to decrease in February or March to support the economy.
- In Japan, Bank of Japan (BOJ) decided to maintain its policy rate unchanged at -0.1% and stick with yield curve control. This decision surprised markets and caused a rapid weakening of the yen as consumer prices excluding fresh food hit 4% annual growth for the first time since 1981.
US equity indices ended mostly lower over the short holiday week, despite a strong rally in Friday’s session for the major averages. Even though Wednesday was the S&P 500’s worst session in more than a month, the benchmark has still managed to post strong gains of more than 4% for the year, closing just shy of the widely watched 4K mark and above its 200-day moving average. Thanks to Friday’s strong rally, the Nasdaq managed to claw its way back into the green after being supported by outsized gains in Large Tech, with GOOGL and NFLX being the largest drivers.
The week was more of the same (outside of Energy) with the worst-performing sectors in 2022 continuing their outperformance in 2023. Communication Services, Technology, and Consumer Discretionary all outperformed the broader S&P 500, with the former 2 adding to the year-to-date gains.
Despite a number of headwinds including poor economic data, fears of a recession and a tepid start to earnings season, a peek behind the actual headlines shows that rotation into cyclicals may be underway as investors start to price in a potential economic recovery in 2024. While only homebuilders have decisively broken out of their downtrend, a number of other industries may soon be testing the top of their declines that have been in place for over a year.
While there is still plenty of room for them to rebound and more gains are needed for them to potentially signal a broader recovery, price action in semi’s, transports and homebuilders have been promising to start the year. While the SOX chip index fell more than 36% in 2022, compared to the Nasdaq at -33%, the SOX has outperformed the broader benchmark since mid-October. Chip stocks are often seen as a proxy for economic growth and despite all indications pointing to slower growth, investors may be playing on hopes for a soft landing (avoiding a recession) which has helped them jump off to a hot start this year.
Despite the soft-landing narrative gaining traction amongst investors, following soft inflation data, there seemed to be a persistent worry underpinning markets this week that the year-to-date strength seen so far is nothing more than another bear-market rally. Contributing to those concerns have been a renewed retail-investor impulse to jump back in the market, paired with some of the largest short covering activity since November.
Throughout the week, inflation concerns were replaced by growth worries after recent economic data suggests a slowing of the economy has already begun to unravel. Weaker economic data includes:
- Overall and core retail real sales falling sharply in December -0.69% and -1.10%, respectively (Both missed estimates)
- Manufacturing PMI weakening more than anticipated, declining -1.3% vs. consensus of -0.2%
- Industrial Production fell -0.7% m/m vs. consensus of -0.10% m/m
This slowing of economic activity and demand destruction is key to the Fed’s mission of returning inflation to trend, but slower growth tends to put markets on edge as firms begin restructuring for a slower economic environment.
Q4 earnings season
With earnings season officially underway, announcements over the next few weeks should continue to be released in a fast and furious manner. Over the course of the week, earnings as a whole deteriorated and the “better than feared” mantra previously thought was quickly forgotten. Last week 26 S&P 500 constituents reported, with the blended earnings decline for the quarter standing at 4.6%, lower than the expected 3.9% decline anticipated by analysts at the beginning of earnings season.
Additionally, the blended revenue growth rate of 3.7% is also below the expected 3.9% at the end of the quarter. The lower earnings are attributed to factors such as waning pricing power, and slowing volume growth and employment costs, which various management teams have highlighted during their corporate earnings calls as they take measures to help try and preserve margins in order to manage through a potential economic environment.
This week will be extremely busy on the earnings front with 93 S&P constituents reporting and should include heavyweights such as MSFT, V, JNJ, TSLA, MA, VZ, T, BA, INTC and AXP.
Layoff announcements continue to pass through big tech firms as 3 of the largest companies began cutting jobs on Wednesday, in a post-pandemic reckoning that has left almost no tech name unscathed. Amazon, Microsoft and Google all shed portions of their workforce, targeting about 42,000 employees globally. All 3 companies have said the painful measures were necessary to offset slowing sales ahead of a possible recession, after experiencing rapid acceleration, and a boom in demand and a jump in e-commerce spending.
While the labor market has remained extremely resilient, investors have seen a significant number of layoffs occur across all different industries and geographic locations. While job openings remained unchanged according to the latest economic report, it is worth noting on an absolute basis they have come down over 12% since its peak in March.
The Bloomberg World index edged down 0.24% last week, led by the growth factor, up 0.62%, while value declined 1.31%. Monetary policy updates as well as forward guidance from policy makers were the highlights of the week. Moreover, the reopening of the economy in China was a major driver for commodities price action ahead of the China New Year holiday. Brent oil climbed 2.76%, maintaining its momentum following its 8% rally the week prior. Emerging markets rallied 0.83%, boosted by Brazil, up 1.01%. Brazil and Argentina announced they plan to work on a common unit of account to enhance their bilateral trade. The dollar index fell 0.18% last week.
In Europe, lenders will get results of year-end real estate appraisals with important consequences for their loan portfolio. As valuations are expected to drop significantly, loan covenants are at risk of being breached, which could engender forced selling. About €390 billion worth of real estate loans, bonds and other debt will mature this year, and a new regulation forces banks to book provisions for expected losses instead of accrued losses. European real estate junk bonds have the highest default risk among sectors of the pan-European high yield index. In Sweden, home prices are expected to take a 20% valuation cut from peak levels, and in the United Kingdom, CBRE Group estimates that commercial properties lost 13% of their value last year.
European Central Bank (ECB) policy maker, Joachim Nagel, said he thinks inflation will return to the 2% target without causing a recession in the Euro area. This scenario is slightly more optimistic than the ECB staff baseline scenario published in December that models a short-lived and shallow recession. European equities seem to agree with this forecast as the Euro STOXX index rallied 8.73% year-to-date. In the United Kingdom (UK), retail sales fell 1% month-over-month as the volume of goods purchased dropped 5.8% year-over-year. UK CPI surged 10.5% year-over-year in December, off the peak of 11.1% registered in November 2022. Consumer confidence remains near historic lows as wages adjusted for inflation are down 4% year-over-year.
People’s Bank of China (PBOC) maintained the five-year lending rates at 4.3% and the 1-year loan prime at 3.65% for the fifth consecutive month. Economists expect rates to decrease in February or March to support the economy. China’s Central Bank has managed to push the average mortgage rate to record low with ongoing quantitative easing. Last Friday, the PBOC injected 381 billion yuan in short-term liquidity via its reverse repos facility. Additional liquidity will be injected into the economy as needed. The Renminbi weakened last week from 6.70 per dollar to 6.78 per dollar, and the China 10-year yield rose to 2.92%. The Shanghai Composite index gained 2.18% last week, led by industrials, up 2.6%. Real estate advanced 1.03% during the same period.
In Japan, Bank of Japan (BOJ) decided to maintain its policy rate unchanged at -0.1% and stick with yield curve control. This decision surprised markets and caused a rapid weakening of the yen as consumer prices excluding fresh food hit 4% annual growth for the first time since 1981. BOJ Governor Haruhiko Kuroda spoke at Davos on his policy and reiterated that the bond market will continue to improve and claimed that the current yield curve control program is sustainable. The current policy framework is expected to last until a new BOJ takes office in April. Prime Minister Fumio Kishida said he will halt speculations and announce the new BOJ head as soon as next month. The NIKKEI 225 index gained 1.66% last week.
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