Market Commentary - January 2024

Monthly Update

After a strong and broad end to 2023, the stock market went back to its narrow ways in January. The S&P 500 and the tech heavy NASDAQ rallied between 1-2% while the small cap Russell 2000 declined by 3.9%[1]. Overseas was very mixed too as the Euro STOXX 600 was higher by 1.4% but the Hang Seng index plunged by 9.2%, while the Japanese Nikkei was higher by 8.4%[2]. On the interest rate side, markets remain very hopeful that the Federal Reserve, along with other central banks, will start cutting rates this year in response to moderating inflation and slower economic growth but the inflation fight is not something I believe they want to give up to easily.

With respect to the US yield curve, short term rates fell a touch while they rose slightly for long end yields. There was a big Fed meeting at the end of the month and markets were positioned about 50/50 according to the fed funds futures for the Fed to start cutting rates in March but Jay Powell quashed that in his press conference. This was followed by a very strong jobs reports, that while it did have some holes in it, further reduced the odds. I think they’ll be looking at the first rate cut in either May or June but will go slowly in reducing them. The other big question, which could get some color at the March Fed meeting, is what they plan to do with their balance sheet in terms of further shrinking it and when to eventually end that process.

Geopolitics has been a big focus over the past year but historically with geopolitical hot spots and events, it rarely has a lasting impact on markets because most of the time, no economic commerce is disrupted. So, while the headline news is scary with the Russia and Ukraine war, Israel fighting Hamas after the Hamas attacks, China’s desire to take over Taiwan, and North Korea continuously testing weapons, unless the supply of oil is blocked, markets look past it. This said, we are seeing the flow of goods impeded by the Houthi attacks on ships in the Red Sea. Container ships are being forced to take the longer route around the Cape of Good Hope which can add up to two weeks to the trip. Also, the cost of transporting goods via a container ship has spiked again. The price of a 40-foot container for the Shanghai to Rotterdam route has gone from about $1,700 at year end to now near $5,000, according to the World Container Index.

We’ll be on the lookout to see how manufacturers and retailers manage this cost jump if it is sustained. Either will get a resumption higher in goods price inflation or a squeeze on profit margins if higher costs can’t be passed on to consumers. The positive with inflation in 2024 should be further moderation in services prices, particularly on the rental market. Rent of a home, either single family or multi family, makes up about 30% of headline CPI and about 40% of the core, excluding food and energy[3]. The data seen from both Apartment List and from multi family landlords themselves point to slowing in the rate of rental price increases. There is a record number of apartments coming on line in 2024, about 1mm units according to Trepp. The lack of new supply past this though will likely lift rental prices again in late 2025 and in 2026 but we’ll deal with that then.

How the central banks view the inflation story will of course drive policy this year but there is one thing to see a deceleration in the rate of change in prices after the 2022 spike and another thing to keep inflation down. Also, the discussion on short term interest rates that the Fed and other central banks control is one thing, where long term interest rates could go is another, particularly in the US.

On the supply and demand dynamic for US Treasuries, the clearing price is now a big focus because of the ever-rising US debts and deficits. For the 12 months ended December 31^st, the US budget deficit as a percent of GDP was 6.5%[4]. That is a record high for an economy that is not in a recession. Since the early 1980’s recession, it ranged between 5-10% at the trough of a recession. If we eventually go into a recession, this budget deficit has the potential of exceeding 10% which means even more US Treasuries need to be sold to finance it. In dollar terms, the budget deficit currently stands at around $2 trillion. So, it is possible that we get into a situation where the Fed cuts short term interest rates and long-term interest rates go up. We’ll see.

I must say the US economy is an extraordinarily confusing picture. There are so many cross currents that creates a very muddy and bifurcated situation. With respect to the US consumer, the biggest driver of growth, the higher income consumer continues to spend on travel, eating out and other leisure and hospitality experiences. Many still want to see live entertainment like sports and concerts. On the other hand, lower and middle-income consumers are more stretched with falling savings and stress from the cumulative rise in inflation and continue to prioritize their spend on more needs than wants. Also, generally, there is less spending on goods relative to services in reverse to the Covid world. The labor market in many gauges has seen a slowing in the pace of hiring, though the recent jobs report complicates the analysis, but a still subdued rate of firings, though every day it seems like we’re hearing about some layoff announcement.

The US housing market is very strange too. The existing home market saw the slowest pace of sales since 1995 in 2023 because of affordability challenges and a lack of inventory[5]. On the other hand, new construction has done better because of the supply need and the ability of the big builders to buy down mortgage rates and discount prices. The manufacturing industry in the United States is experiencing a downturn, mirroring a global trend where excessive inventories are being reduced. Additionally, consumers are prioritizing spending on services rather than goods, contributing to the economic challenges faced by various regions worldwide. Business investment in 2023 was flattish. Lastly, government spending, as seen in the big deficits, along with the government legislation of the CHIPS Act, the wrongly named Inflation Reduction Act and the infrastructure bill are all injecting huge amounts of money into the US economy.

Conclusion

The S&P 500 ended 2023 at about the same exact spot it started 2022, but with a lot of stomach churning moves up and down in between. There remains a wide spread between the action in the very biggest cap names and everything else with the former doing much better than the latter, still. We enter 2024 with hopes of Fed rate cuts and moderating inflation but fears of slower economic growth and sticky inflation. If the Fed cuts just a few times that could imply the economy remains resilient. If they cut more aggressively it might mean the economy enters a recession and the unemployment rate goes higher. It’s certainly a confusing picture for sure.

There is also a continued long runway where the economy needs to further acclimate to this higher interest rate environment, particularly for the very interest rate sensitive sector that is commercial real estate where many refinancing challenges are being seen. After a lengthy period of about 15 years of extraordinarily low and artificially suppressed interest rates, the new higher rate backdrop continues to evolve, and the transition is certainly bumpy and still could be for a period. The adjustment and withdrawal period from the low-rate world will continue and impact both economic activity and markets, both up and down.

I am still of the belief, until proven otherwise, that we’re in a possible multi-year stock market trading range which we are at the upper end of. On the interest rate side, short-term rates have seen their peak with the Fed likely to cut rates this year, though is already priced in. Long-term rates, as stated, I believe still have the potential of rising after the recent pullback.

We acknowledge that we live in a different macro world and need to have eyes wide open on how things proceed from here. Whatever comes our way in this very tricky investing landscape, it remains vital that investors have adequate short-term liquidity over the next 2-3 years. Knowing that period is covered can help separate the balance of one’s portfolio from the ups and downs of the market. Time horizon is always crucial and is always the best friend of any investor. We are in the risk management business and always believe that by watching our back and focusing on the risks, the upside should take care of itself.

Disclaimer

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The market and economic data is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The information in this report has been prepared from data believed to be reliable, but no representation is being made as to its accuracy and completeness.

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The NASDAQ Composite Index measures all NASDAQ domestic and non-U.S. based common stocks listed on The NASDAQ Stock Market. The market value, the last sale price multiplied by total shares outstanding, is calculated throughout the trading day, and is related to the total value of the Index.

The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.

The Stoxx Europe 600 index also called the STOXX 600 is an indicator of the performance of the European stock market. It measures the performance of large mid and small-cap companies across 17 countries in Europe. The number of constituents is fixed at 600.

The Hang Seng Index is a freefloat-adjusted market-capitalization-weighted stock-market index in Hong Kong. It is used to record and monitor daily changes of the largest companies of the Hong Kong stock market and is the main indicator of the overall market performance in Hong Kong. These 82 constituent companies represent about 58% of the capitalization of the Hong Kong Stock Exchange.

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[1] Bloomberg

[2] Bloomberg

[3] Bloomberg

[4] Bloomberg

[5] Bloomberg