Central banks signal a shift in tone, European equities rally on a recession delayed, and investors shrug off a weak earnings season.
Jacob Manoukian, U.S. Head of Investment Strategy
Sarah Stillpass, Global Investment Strategist
Our Top Market Takeaways for February 03, 2023.
Market update
The bulls are back in town
The initial descent. The big takeaway from the week is that central banks seem pleased with the progress they have made on inflation, even if they aren’t ready to declare victory. The Federal Reserve raised rates by only 25 basis points (bps), and Chair Powell used words such as “welcome” and “gratifying” to describe the most recent “disinflationary” data. Meanwhile, in Europe, Christine Lagarde also conceded that the inflation picture has improved, even though she vowed that another 50-basis-point hike was coming in March.
While the campaign against inflation isn’t over, the tone has clearly changed. Perhaps most importantly, the Fed seemed disinterested in the market rally so far this year—a notable shift from communication last fall that was designed at least in part to raise credit spreads and lower equity prices. The inflation emergency is over, while the latent risks to growth remain.
AGGRESSIVE RATE HIKING CYCLES ARE COMING TO AN END
The chart shows the Fed Funds Target Rate versus the European Central Bank Deposit (ECB) Rate from January 2019 through February 3, 2023. In January 2018, the Fed Funds Target Rate and ECB Deposit Rate were 1.50% and -0.40%, respectively. In January 2019, the Fed rate was 2.50%, whereas the ECB rate was still in the negatives at -0.40%. In February 2020, the Fed rate was 1.75% and the ECB rate was -0.50%. The ECB rate remained at -0.50% until January 2022. It then moved to 0% in January 2022 before climbing into positive territory at 0.75% through August 2022. From there, the ECB deposit rate continued to climb and finished 2022 at 2%, and currently sits at 2.5% as of February 2, 2023. The Fed rate was 1.25% by March 2020 and then was brought down significantly to 0.25% by March 2020, where it stayed through March 2022, when the first hike was made. By June 2022, the Fed rate hit 1.75% after multiple hikes, and then continued to move to 3.25% by October 2022, and by December 2022, it was 4.5%. In February 2023, another Fed rate hike occurred, and the rate now sits at 4.75%.
Dovish reaction. Markets rallied this week. Bond yields fell across the curve, with 2-year Treasury yields dropping to their lowest levels since October. Ten-year Treasury yields dropped below the technically important 3.5% level, and 30-year mortgage rates are approaching 6%. Markets are still implying an ~80% probability of another 25-basis-point hike at the next Fed meeting in March, but it seems like risks are finally skewed toward the Fed doing less than that. Core bonds, our top idea heading into the year, have returned close to 4% already.
Equities cheered this week. The NASDAQ 100 ripped by over +4%, while the S&P 500 gained over +2%. Some interesting cyclical names made new 52-week highs, including Pulte, DR Horton, Lennar, Wynn, Starbucks, Tapestry, and ON Semiconductor. European equities surged to post-invasion highs, and are now flat over the last year.
The VIX implied equity volatility index closed at one of its lowest levels of the last year, and the MOVE implied bond volatility index made its lowest close since last March. Lower volatility is welcome news for investors. We did think markets would be stronger in 2023, and a 10% year-to-date rally in global equities is a great start.
EUROPE HAS OUTPERFORMED THE U.S. OVER THE LAST YEAR, AND TECH HAS SURGED RECENTLY
This chart shows the index price return for the S&P 500, NASDAQ 100 and STOXX Europe 600 from February 2022 through February 2, 2023. The indices have similar stories, but STOXX Europe 600 has outperformed throughout the past year. On February 2, 2022, the S&P 500 total return was 0.9%. By the end of March 2022, it was 1.5%, and by the end of June 2022, it was down a whopping -16.2%. It gained back a small bit of ground by the end of August 2022, returning -12.2%, and by the end of October it was -13.8%. It finished the year at -14.2% and has since regained a significant amount to close at -6.5% on February 2, 2023. On February 2, 2022, the NASDAQ 100 total return was 0.8%. By the end of March 2022, it was 0.5% and by the end of June 2022, it was down significantly at -23.1%. By the end of August 2022, it returned -17.9%, and by the end of October it was down -23.6%. It finished the year down -26.6% and remains down, as it closed at -14% on February 2, 2023. On February 2, 2022, the STOXX Europe 600 total return was 0.5%. By the end of March 2022, it was -2.1%, and by the end of June 2022, it was down significantly at -10.4% (still less than its S&P 500 and NASDAQ 100 counterparts). By the end of August 2022, it was down -7.9%, and by the end of October it was down -11.7%. It finished the year down -7.2% and remains barely in the red, as it closed at -1.5% on February 2, 2023.
Mixed bag for data. Besides the Fed, there were plenty of data points for investors to parse through. This morning, the latest employment report crushed economist expectations, and showed that the United States economy gained over 500,000 jobs in the month of January, while the unemployment rate fell to 3.4%. While there could be some seasonal quirks that overstate the strength, this reduces near term recession risk, but also confirms that the Fed will probably still raise rates one or two more times during this cycle.
The S&P Manufacturing PMI for the US stabilized at 46.9 (verses 46.2 last month), while the ISM Manufacturing survey deteriorated further to 47.4. Markets were much more focused on the Fed’s decision and tone, and would probably justify the economic weakness as proof that higher rates are having their intended impact.
The most perplexing piece of data was probably the JOLTS Job Openings, which signaled a surge in labor demand from companies despite the plethora of headlines about layoffs from the tech sector.
Over in Europe, headline inflation came in softer than expected (8.5% YoY verses 8.9% expected), thanks to the big drop in energy prices. While the core measure was still firm (5.2% YoY), falling energy prices will help alleviate the cost-of-living crisis and will help improve the outlook for the region.
EUROPEAN ECONOMIC DATA HAS BEEN SURPRISING TO THE UPSIDE
This graph shows the Citi Economic Surprise Index for Europe from January 4, 2016, until January 17, 2023. The first datapoint for the Europe was 15.9. From there, Europe rose to 59.5 by November 17, 2017, then it declined to -94.3 and then climbed to -9.3, by July 24, 2019. Here, Europe hit 58.3, then it declined to an all-time low before rising back to an all-time peak of 180 by August 19, 2020. Then it dropped to -69.1 by November 1, 2021. From there until recently, it rose to 78.2 in January 2023 and hit 86.5 in February of 2023.
Learnings from earnings. While the outright read of this quarter’s earnings season is pretty weak (earnings have surprised to the downside in aggregate relative to a +4.1% average beat over the last four quarters), the market has largely shrugged it off. Just last night, behemoths Apple, Amazon and Alphabet reported lackluster results, but that has merely dented the year-to-date rally.
On the other hand, perhaps the star of earnings seasons so far has been Meta (nee Facebook), which surged by ~25% after reporting stronger than expected results and outlining a plan to return capital to shareholders through buybacks.
What it means for you. In our outlook, we wrote that markets were presenting investors with potentially one of the best entry points for a balanced portfolio of stocks and bonds in a decade. Even though markets have started the year off stronger than most could have imagined, those that are building a long-term portfolio should still feel confident about putting their capital to work.
The major headwinds of 2022 (inflation, hawkish central banks and a collapse in housing activity) are receding, while the prospects for Europe and China are improving. The U.S. economy is not out of the woods, but the rally that we have seen to start the year signals that expectations are still low. Most importantly, investors have compelling options across asset classes, geographies and investment styles, at least for now.
Please reach out to your J.P. Morgan team for more on the opportunities that we see, and how they might fit into your financial plan.
All market and economic data as of February 2023 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.
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