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What a start to the year! Equity markets across the board finished the month of January strongly in the black, and so did bonds. However, we may want to take the solid start of the year with a grain of salt. There were a few factors that led to the strong equity market returns that may be less supportive moving forward.
· According to Bloomberg, there have been high levels of short covering as pessimistic investors had to buy stocks to cover their positions. Short covering can be a catalyst for upside momentum in the markets. However, this tends to be a short-term stimulus for markets.
· There has been a strong turn in the AAII bull/bear Investor Sentiment Survey. Bullish sentiment rose to 30%, the highest level of optimism since mid-November 2022. The bull-bear spread remains in neutral territory.
· Although the U.S. Federal Reserve increased their federal funds rate by 25 bps and indicated that there aren’t likely done, the market is starting to price in the end of the rate-hike cycle and perhaps looking forward to the beginning of a rate-cut cycle. I believe that the expectation of rate cuts beginning this year are likely overly optimistic. The better narrative should be “don’t fight the Fed” and take them at their word when they indicate that rates are likely to remain elevated longer than expected.
· Earnings are coming in slightly better than expected. We’re at the halfway point in Q4 earnings for the S&P 500 Index and they’ve surprised to the upside on average. At time of writing, 251 companies have reported with 70% of them beating estimates. Bloomberg indicates that earnings growth surprise is at 1.3% while actual earnings growth is –3.1%. Not as bad as feared showing continued resilience in corporate America.
· Buybacks are making a comeback, according to Bloomberg. In January, announced buybacks more than tripled to US$132 billion from a year ago, the highest total ever to start the year.
· Lastly, seasonality may be at play as well. Historically January is one of the best months of the year for stock market performance and after a year that was 2022 one could argue that investors were looking for any catalyst to get the market moving in a positive direction.
With that being said, I remain reasonably optimistic for the full year for both equities and fixed income, and we have likely already seen the bottom in both. I would advise that we could continue to expect choppiness over the near term as more data on earnings, jobs, inflation, economic growth, and the Fed’s ultimate response to those comes to light. In this environment, I continue to prefer a dollar-cost averaging approach to investing in this market with the flexibility to increase market exposure should we get any material downturns.
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