Powell's Not Done: January Recap and February Outlook
The market adage is "as January goes, so goes the year." Is it true? According to an analysis by Fidelity, January returns are positive about 75% of the time the full year turns out positive.
The recent rally was certainly a relief after last year's dismal performance. While stocks and bonds are still positively correlated, the return to solid bond performance at least means the 60/40 has a chance of righting the ship.
But the data continues to be open to interpretation. Strong economic indicators like employment, a better-than-expected earnings season, and consumer spending don't seem to match the rapid change in GDP expectations.
Let's get into the data:
12-month CPI was 6.5% in November. The Bureau of Labor Statistics reported the number was the smallest increase since October 2021.
The January non-farm payroll number was 517,000. The report from the Department of Labor was 187,000 jobs above the consensus estimate.
The unemployment number is now at 3.4%. For historical context, the last time it was it hit this level was the year of the moon landing.
Fourth quarter real GDP was 2.9%, according to the U.S. Bureau of Economic Analysis's first estimate released on January 26. The Atlanta Fed's GDPNow model estimate of 1Q GDP was 0.07% on January 27.
What Does All of That Data Add Up To?
The 25-basis point increase to the critical short-term rate marked a return to more normal Federal Reserve behavior, making minor, incremental changes to fine-tune the economy. However, Powell's comments at the press conference following the meeting could be viewed as the Federal Reserve equivalent of the groundhog seeing his shadow (which he did).
We're in for six more weeks of seasonal winter and however many months of Fed rate hike winter. The markets reacted with a wink and nod and interpreted the remarks as dovish. The received wisdom seemed that with inflation trending down, the Fed would blink and return to propping up markets when faced with slowing growth.
However, the blow-out non-farm payroll number brought a different message. The best interpretation is that the underlying strength of the economy is proving resilient as job growth continues, demand switches back to services, supply chains unkink, and inflation eases back to more normal levels.
Such robust data allows Powell to permit the rate hikes already enacted to work through the economy. Recent messaging from Fed governors indicated that the possibility of a soft landing is getting less remote.
That doesn't square with what Powell said in the press conference, in which he cited a labor market this is still out of balance and labor force participation that is unchanged from a year ago. Despite substantial evidence indicating that inflation is on a sustained downward path, Powell noted, "This is not grounds for complacency."
That may be interpreted as the Fed needs to move the terminal rate upwards from the recently projected 5.1% peak and keep it higher for longer.
Given the mismatch between Powell's language, the incoming economic data, and the continued strength of the labor markets and the consumer, volatility is likely to continue.
This all means we are likely not out of the woods yet. We're still not done with this fed funds rate cycle, and the trajectory is already the steepest since the mid-1980s.
Equity Markets in January
The S&P 500 was up 6.18%
The Dow Jones Industrial Average gained 2.83%
The S&P Mid-Cap 400 increased by 9.14%
The S&P Small-Cap 600 rose 9.40%
*Source: S&P. All performance as of January 31, 2022
January saw eight of the eleven S&P 500 sectors up and Consumer Discretionary in the lead, up 14.99%. Earnings season has so far outperformed. As of 170 issues reported, 119 (70.0%) have beaten earnings, and 107 of 169 (63.3%) exceeded expectations on sales. Q4 earnings are expected to post a 2.7% gain over Q3 2022 and be down 8.8% over Q4 2021.
The 10-year U.S. Treasury ended the month at a yield of 3.50%, a decrease from 3.88% in December. The 30-year U.S. Treasury ended December at 3.63%, down from 3.97% last month. The Bloomberg U.S. Aggregate Bond Index ended January with a return of 3.08%. The index continued the positive correlation trend between the equity and bond markets.
The Smart Investor
The watchword for this year is patience.
A strong January makes an excellent start to the year, but volatility is likely still on the horizon. Until the terminal rate for the Fed is clearly in view, markets will react to ongoing data.
The Fed's March meeting may provide some clarity, but Powell has been very consistent in his ongoing fear that pausing – or reducing – rates too soon could result in inflation remaining too high. A booming job market cushions the economy but makes the job of the Fed far more complex.
There are some tactical things you may want to think about:
Diversification remains a challenge. Ensuring that your portfolio is adequately diversified by adding non-correlated assets can help smooth volatility.
Timing an entry or an exit is very difficult to pull off successfully. There may be some false starts before a recovery gets fully underway.
A big-picture focus can be valuable in your financial planning and investment strategy. Consider sticking to your long-term plan (so long as it still is appropriate for your goals) and avoid trying to time the markets as we get to the home stretch on this Fed rate cycle.
If you are navigating your finances and trying to understand how your finances can enable you to achieve your goals, feel free to place a complimentary 30-minute meeting on my calendar. In that meeting, we can discuss your objectives and situation.
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