Following the everything-rally that was the last two months of last year, performance across asset classes was mixed in January. Stronger than expected economic growth data and strong pushback from central bankers against the market’s overly enthusiastic expectation for rate cuts produced a tough environment for fixed income (U.S. Agg – chart below). Even though lower rates at the end of last year fueled gains in equities, segments of the equity market were buoyed against rising rates in January by the stronger economic growth data. One of those segments was mega-cap growth – an echo of last year’s Magnificent 7 phenomenon. Compare the returns of the cap weighted S&P 500 Index to its equal weighted sibling and the small cap Russell 2000 Index. Emerging market equities were down -4.6%, despite newly announced stimulus from the People’s Bank of China (PBOC). A mixed month, indeed.
Given the geopolitical backdrop, the development of an unknown unknown(s) (aka Black Swan event(s)) has a higher probability than usual. However, financial markets discount known unknowns (macroeconomic trends mostly). Investors just have to live with the possibility of a Black Swan and react to them when they do arrive (Q12020’s COVID is the most recent example).
All that said, barring an unexpected shock to the global financial system, I suspect January’s mixed results may be foreshadowing the next six months. Rate cuts are coming, but the people who cut them are saying the second half of the year. Economic growth looks good for now but the credit environment is tightening (New York Community Bank) and rounds of layoffs are being regularly announced. Should a “soft landing” turn into a no-landing event, we can cancel the rate-cut party.
I do not see a trap door for the equity market to free-fall down through (no Black Swan disclaimer), but similarly, I do not see much bull market fuel in an environment where the Fed is braking the economy in order to tame inflation.
There is still opportunity in Mixed.
Be well,
Mike
Sources: Addepar, BCA Research, Bloomberg, Dorsey Wright & Associates, Ned Davis Research
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