Finding a Bright Spot

HIGHLIGHTS:

• Stock and bond market gauges have climbed higher so far this year, particularly after last week’s inflation print.
• Domestically, investors are focused on a potential slowdown in the Fed’s rate hikes, but also in the US economy.
• Market odds show the Fed will likely raise rates by 0.25 percent in February and March.
• The fourth-quarter earnings season just kicked off, and expectations are fairly low, leaving room for corporate outperformance.

Financial markets show signs of recovery over the first few weeks of the year as a wary optimism percolates through both stock and bond markets. US stocks, measured by the S&P 500 Index, have gained 4 percent in 2023 through yesterday. The consumer discretionary, materials, and communication services sectors led the advance. Meanwhile, international and emerging market stocks have both gained about 7.5 percent over the same period. Some of the disparity is explained by a weakening US dollar and more focus on US rates and the domestic economy for investors.

The Federal Reserve may finally see a path toward calling it quits—at least concerning its rate hike program. Last week, government data showed that inflation declined to an annualized 6.5 percent pace in December. The result was in line with expectations, showing signs of a further easing in consumer prices. It also seems to prove that the aggressive monetary policy over the past year is achieving the desired results and leaves the door open for Fed officials to slow their pace of hikes. However, resilient consumer demand and a stubbornly tight labor market remain obstacles for the Fed and its inflation goals. Markets are now wagering the Fed will raise rates by 0.25 percent in February and once more in March before pausing to determine the path forward as expectations for a growth slowdown come into focus. Bond markets also seem to be pointing to some economic turbulence, with the benchmark 10-year Treasury rate declining to 3.4 percent.

Looking forward, investors will likely be concentrating on the fourth-quarter earnings season to find a bright spot amid recent gloomy economic data, such as weakening retail sales and declines in manufacturing. The reporting season has just kicked off, and there definitely seem to be some positive surprises. However, investors are closely watching the results of the banking industry as a gauge for the underlying economy. Currently, Wall Street analysts expect an overall decline in earnings by 3.9 percent in the fourth quarter and marginally negative results in both the first and second quarter of this year. While the bar is set fairly low, it does leave room for corporations to outperform.

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