- Major indexes closed higher for a second straight week, posting their first back-to-back weekly gains in more than a month.
- The risk-on tone was largely driven by the soft-landing narrative, which picked up steam after the release of December’s CPI numbers which showed inflation fell to 6.5% y/y, in line with expectations and the lowest in 14 months.
- Upside for the week was driven by large tech companies, the FANMAG complex, solar, semiconductors, retail, homebuilders, and travel-related names. Banks, which kicked off earnings season in the latter part of the week, were in line with the broader market.
- Garnering as much attention from the report was 1-year inflation expectations which fell to 4.0%, the lowest since June 2021, which helped drive a boost in consumer sentiment.
- According to CME’s FedWatch tool, the probability of a 25bp hike in February now stands at approximately 90%, up from 80% prior to Thursday’s CPI release.
- Last week started the final earnings season for 2022 with major banks kicking off their announcements. Estimates call for a 3.9% decline in 4Q earnings, however, early results suggest that these concerns may be overdone, since 23 of the 29 reports have reported a positive EPS surprise.
- 20 of the 29 S&P 500 companies have reported a revenue surprise.
- Christine Lagarde, European Central Bank President, announced that the pace of rates increase will likely slow to 50bps in February, followed by 25bps in March. The Euro STOXX index gained 2.88% last week.
- Headline inflation in the Eurozone is back to single digit after the ECB raised rates 250bps in the past six months. A Bloomberg survey of economists estimates rates to peak at 3.25% in June, followed by a rate cut in July.
Major indexes closed higher for a second straight week, posting their first back-to-back weekly gains in more than a month. The S&P 500 ended the week just below 4,000, while the Nasdaq finished above 11,000, the highest close for both indexes in a month.
Growth and value factors were in line with one another as both posted gains of more than 2.5%. The risk-on tone was largely driven by the soft-landing narrative, which picked up steam after the release of December’s CPI numbers. The appetite for risk assets appeared to be visible in most places investors looked, at least to start the year. Meme stocks are having a moment again, airlines are up more than 15% year-to-date and massively outperforming the broader market, while small caps are up over 4% in the first 13 days of 2023.
Upside for the week was driven by large tech companies, the FANMAG complex, solar, semiconductors, retail, homebuilders, and travel-related names. Banks, which kicked off earnings season in the latter part of the week, were in line with the broader market, despite earnings announcements that were seen as “better than feared.” There were a few pockets of weakness, including food and beverage names, auto part retailers, and pharmaceutical companies. From a sector standpoint, only Consumer Staples and Healthcare finished the week lower, with almost all other sectors outperforming the broader markets.
Treasuries were generally firmer, with the largest gains seen in the middle of the curve as the 10-year yield finished the week at 3.50%. US investment-grade bonds had their best start to the year in a decade, tightening 8 bps throughout the week, led by longer-duration bonds, indicating that traders are positioning for lower yields. With very short-duration bonds also performing well, credit investors appear to be deploying a so-called barbell strategy, betting on a decline in yields but also hedging themselves by buying shorter-duration issues, given the uncertainty that rates may not, in fact, be lower if inflation remains higher than expected.
CPI and Inflation
Following December’s CPI report, investors were able to breathe a sigh of relief, hailing the release as “better than feared,” even as results were in line with estimates. The report showed a 6th consecutive monthly decline, with the year-over-year gain falling to 6.5%, which was the lowest in 14 months. Along with the release, there was an equally large focus on the report’s 1-year inflation expectations. Respondents said they expect prices to increase 4.0% over the next year, the lowest since June 2021, and its fourth consecutive monthly decline, which helped provide a bigger-than-anticipated boost to consumer sentiment.
The inflation report, combined with other employment metrics (including December’s payroll data), continued to offer more hope around the potential for a soft landing, as Americans appear to be feeling increasingly upbeat about the economy and their finances, with prices at the pump falling sharply from their summer highs, grocery inflation slowing, and unemployment remaining near a five-decade low.
Even with inflation metrics continuing to decline and support for the Fed to scale back their rate hikes to 25bps from 50bps, hawkish Fed members continue to reiterate the need for higher rates and continue to push back against market expectations, which call for rate cuts by the end of the year. Various members of the central bank continue to stress the “higher for longer” narrative, not offering much more in the way of clues than the possibility of a pause once rates surpass 5%.
According to CME’s FedWatch tool, the probability of a 25bp hike in February now stands at approximately 90%, up from 80% prior to Thursday’s CPI release. The dichotomy between the Fed’s messaging and market expectations continues to grow, with markets currently pricing in 2 rate cuts by the end of 2023, reflecting the risk that positioning among investors may catch some off guard if the rate cut expectations do not materialize.
Last week marked the start of the final earnings season for 2022, with major banks kicking off their announcements. Despite expectations calling for a 3.9% decline in Q4 earnings (which would mark the first quarterly decline since Q3 2020 when it fell 5.7% due to headwinds from high inflation, elevated labor costs, and businesses trying to insulate themselves ahead of a potential recession heading into 2023), early results suggest that these concerns may have been overdone.
So far, with 29 S&P 500 companies reporting actual results, 23 of them have reported a positive EPS surprise, while 20 of them have reported a positive revenue surprise. Following bank earnings, United Airlines announced better-than-expected results, which helped send positive macro signals and reinforced the view that the consumer remains strong and demand remains healthy, which could help the Fed potentially engineer a soft landing.
The Bloomberg World index advanced 3.36% last week, led by the growth factor, up 5.13%, while value climbed 1.57%. Mean reversion seems to be in full swing, with growth stocks coming back in favor as investors are already focused on the post-hike cycle. Volatility contracted in recent weeks despite the earnings season kickoff. This week, economic leaders meet at Davos for the annual meeting of the World’s Economic Forum. One of OPEC’s top officials said he is cautiously optimistic about the outlook of the global economy as rising oil demand from China is offset by weakness in other major markets. Brent oil futures rose 8.54% last week.
Christine Lagarde, European Central Bank President, announced that the pace of rates increase will likely slow to 50bps in February, followed by 25bps in March. Headline inflation in the Eurozone is back to single digit after the ECB raised rates 250bps in the past six months. A Bloomberg survey of economists estimates rates to peak at 3.25% in June, followed by a rate cut in July. Natural gas prices continue to decline amid lower demand than expected. The Euro STOXX index gained 2.88% last week, led by real estate, up 7%. Technology stocks jumped 6.81%, while financial services advanced 3.85%.
In Germany, Chancellor Olaf Scholz revealed in a Bloomberg interview that he thinks the economy is doing well and that a recession is not likely. A Bloomberg survey of Economists upgraded Germany’s fourth quarter GDP forecast to 0%, which supports the view that the economy will perform better than expected. Regarding the energy crisis, Scholz said that Germany learned its lesson and that more supply chain diversification should be expected in the future. The ZEW expectations index, which measures investors’ sentiment of the German economy, soared to the highest level in a year. The DAX index gained 3.26% last week.
China Vice Premier Liu He said at Davos that China’s economy will rebound as COVID-19 infections already peaked and business activity is normalizing. He also addressed concerns regarding China’s trade policy. According to him, “China’s national reality dictates that opening up to the world is a must, not an expediency.” He then added, “We must open up wider and make it work better. We oppose unilateralism and protectionism”. 2022 was a tough year for China, with retail sales contracting and industrial output shrinking amid COVID-Zero policy. Economists expect China GDP to rebound 4.9% in 2023. The Shanghai Composite index gained 1.19% last week.
In Japan, Bank of Japan is less than a year way from running out of bonds to buy according to Bloomberg. The Central Bank bought $126 billion worth of bonds in just five days to cap yields. Bank of Japan now own 53% of the bond market, up from 52% a month earlier. In the last three trading sessions, the 10-year yield rose above the upper bound ceiling as traders bet yields will peak around 0.8%. Bank of Japan announced on Tuesday another unlimited buying program for the 5 and 10-year Japanese government bonds. As of Tuesday, the yen stands at 128 per dollar, pausing the rally staged in recent weeks. The NIKKEI 225 index advanced 0.56% last week.
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