The ”January Effect” is the historic tendency for stock prices to rise in the first month of the year. There are multiple factors that are hypothesized to be behind any potential bull rally such as December tax loss harvesting, year-end bonuses and renewed consumer optimism. Despite this, we remain factual in our analysis of the economy and geopolitical situation to make the best investment decision for your portfolios.
In this economic update, we will share our insight on the many facets shaping the current macroeconomic environment, their impact on financial markets and our plan for 2023.
Inflation is so 2022… Not really
During the first couple of weeks in 2023, it seemed that investors suppressed the idea of inflation from their minds and deployed capital in the market in the hope of seeing declining inflation for the month January. Lo and behold, the consumer price index (CPI) rose 0.5% in January and came in at 6.4% for the 12 months period ending January 2023. That’s slightly lower than December 2022 (6.5%) but higher than the expectation of 6.2%. The U.S. central bank has been very aggressive in trying to control inflation, having hiked its benchmark interest rate eight times since March 2022. A down trend in inflation readings from its peak offered optimism that inflation could be controlled via monetary and fiscal policies to avoid a recession. Nevertheless, the January data reminded everyone that the path to lower inflation will be difficult, offering no guarantee on the efficiency of higher interest rates on the long run. Recently, Fed chair Jerome Powell offered his outlook for 2023, addressing the question of interest rates. The key takeaway is to expect a couple of rate increases this year and for rates to stay high in the near future. As such, the full extent of the Fed’s hawkish attitude favoring higher interest, is still unclear and might reserve a few unexpected surprises along the way.
A new era of quantitative tightening
Quantitative tightening, also known as "QT," is a monetary policy tool used by central banks to decrease the money supply in an economy. Quantitative tightening is the opposite of quantitative easing (QE), which involves buying government bonds and other securities to increase the money supply and stimulate economic growth. In QT, the federal reserve reduces its balance sheet by selling assets such as government bonds. Following more than 10 years of QE, in 2022 the central bank started a new QT program. As of September 2022, the Fed started cutting back its bond portfolio by about $95 billion per month by avoiding the purchase of new securities to replace maturing bonds. The balance sheet remains high, at roughly $8.5 trillion, down less than 6% from its peak in April 2022. As QT is rolled out, it will create upward pressure on interest rates and cost of borrowing while potentially reducing available short-term liquidity. This, in turn, will slowdown economic growth and can have a negative impact on the stock market.
The U.S. debt limit
As of January 2023, the United States has reached its debt ceiling of US$31.4 trillion, which has compelled policymakers to take unprecedented measures to prevent the country from defaulting. Negotiations are currently underway in Congress to devise a solution to raise the debt ceiling by the start of summer. Any news or developments related to this issue are likely to affect both the bond and stock markets and create market volatility.
Geopolitical tensions
On February 24th, 2022, Russia decided to invade Ukraine and few where those who expected it to last this long, fearing a swift and decisive takeover by Vladimir Putin’s troops. The Ukrainian army has put a valiant effort to resist Russian invasion efforts, turning the antagonism in a much larger East vs West conflict. Western allies have been sending weapons to Ukraine while ties between the world's two largest economies have been strained after the U.S. military shot down a suspected Chinese spy balloon. Tensions between the U.S. and China have been high in recent years, with both nations engaging in a range of economic, political, and military disputes.
Corporate earnings and labour market
Analysts have reduced their earnings-per-share (EPS) estimates for all companies in the S&P 500 index for the first quarter of 2023. The median EPS estimate has been lowered from $54.20 to $51.13, which is a significant decrease. The continued high cost of capital is affecting the daily operations of companies, leading them to adopt cost-cutting measures in order to maintain a sustainable working capital. This includes workforce reduction through layoffs, and it is unclear when this trend will come to an end. Despite the tech layoffs, the U.S. labour market continues to be strong with lower numbers of Americans filing for unemployment. For the week ending on February 25th, unemployment claims were 190,000 against an expected 195,000. When unemployment decreases, it typically leads to an increase in purchasing power and consumption for the U.S. population. However, this can also lead to higher inflation, posing a challenge for the Federal Reserve in their efforts to control inflation. This paradoxical situation can make it more difficult for the Fed to balance their efforts to boost economic growth and employment while keeping inflation in check.
Market outlook
Based on the information provided in the economic update, caution and prudence continue to be the North Star of our portfolio management strategy for 2023. We have strong reservations about the market’s capacity to sustain its positive performance throughout the year. It is our belief that the stock market will be volatile. Nevertheless, there is money to be made with bonds and money market instruments. We continue to overweight fixed income and cash positions contrarily to equity in your portfolios, since we are not comfortable with the risk - return profile of stocks. The fear of a recession still looms, and it would be rash to aggressively deploy capital in the market without any clarity on the future path of interest rate and inflation.
Conclusion
Our team has over 35 years of combined experience in wealth management and has dealt with many market cycles. We understand the mechanics of both bear and bull markets and how to invest money accordingly to maximise value while offering adequate downside protection.
We thank you for your continued trust, and we remain available to answer any questions you may have.
The particulars contained herein were obtained from sources we believe to be reliable, but are not guaranteed by us and may be incomplete. The opinions expressed are based upon our analysis and interpretation of these particulars and are not to be construed as a solicitation or offer to buy or sell the securities mentioned herein. The opinions expressed do not necessarily reflect those of NBF. I have prepared this report to the best of my judgment and professional experience to give you my thoughts on various financial aspects and considerations. The securities or sectors mentioned in this letter are not suitable for all types of investors and should not be considered as recommendations. Please consult your investment advisor to verify whether the security or sector is suitable for you and to obtain complete information, including the main risk factors. Some of the securities or sectors mentioned may not be followed by the analysts of NBF.