There was no shortage of gloom as the New Year began. The Federal Reserve was signaling higher interest rates, and its aggressive campaign, started last year, to rein in inflation has been threatening to throw the economy into a profit-killing recession.
While investor sentiment is far from euphoric right now, 2023 is off to a strong start. What’s behind the move?
Last year, the Fed hiked its key lending rate, the fed funds rate, by .75% in four consecutive moves.
Mix in a .50% increase in December and .25% increase back in March, and we experienced the most aggressive tightening cycle in over 40 years (St. Louis Federal Reserve) since the end of 1980. Ronald Reagan had just been elected President and was soon to be inaugurated.
While the Federal Reserve is not yet signaling a halt to rate hikes and commentary suggests it could hold rates at a high plateau this year (what analysts have been calling ‘higher for longer’), the pace of rate increases is set to slow from last year’s nearly unprecedented level.
But are investors ahead of the Fed? Or are they too optimistic about rates? Fed officials pushed back aggressively last year on a 2022 pivot.
Today, investors believe we may see at least one rate cut by the end of the year. Previously, that had not been in the Fed’s game plan, but Fed Chief Powell seemed less wedded to pushing rates above 5% at the February 1 press conference.
While Powell isn’t declaring victory on inflation and he isn’t ready to hint at a turnaround, he was more open to the recent moderation in inflation. The initial reaction was positive.
Looking ahead, a significant rise in the jobless rate would probably force the Fed to cut rates, but a drop in corporate profits could negate any benefits from falling rates.
How the Fed responds will be heavily influenced by how the economic outlook unfolds.
An opaque crystal ball
From 1970 through 2021, the January return on the S&P 500 Index exceeded 5% on 10 different occasions (St. Louis Federal Reserve data). Excluding reinvested dividends, the S&P 500 finished the year higher nine times. The 90% ‘win ratio’ beats the average since 1970 of 74%.
During the 10 years when January advanced by 5% or more, the S&P 500 averaged a return of 21.5%. Its best annual return was 31.6% in 1975, which followed the difficult 1973-74 bear market. Its only loss was 6.2% in 2018. What we know for certain is that each economic cycle has its own peculiarities.
Certainly, past performance is not a guarantee of future results. Ultimately, the economic fundamentals will tell the story as the year unfolds. We continue to advise caution with the leading economic indicators pointing towards a slowing economy and a persistent inversion of the yield curve (short term rates higher than long term rates) which have historically indicated recession is ahead.
If you have any questions or would like to discuss any matters, please feel free to give me or any of my team members a call.
As always, we are honored and humbled that you have given our team the opportunity to serve as your family.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Investing involves risk including loss of principal.