Six More Weeks of Winter Indeed
When we last checked in with famed meteorological marmot Punxsutawney Phil, he had elected to hunker down for a few more weeks of rest, having been frightened by his shadow on his big day. There was speculation at the time that Phil had surreptitiously ventured forth in January; of course, it is quite well known in western Pennsylvania that Phil is a self-described “stock market maven,” and he apparently was seen exchanging alfalfa and clover for dollars to add to his Robin Hood account during the January rally. Hopefully, Phil’s fearfulness kept him off his trading app in February, because, well, Phil would be fairly despondent, and nothing’s more depressing than a sad, frightened groundhog who’s lost his mojo.
As ebullient as markets were in January, they were dismal in February. While most market indices were still quite positive year-to-date, much of the gains scored in January were forfeited last month, as bets that the Fed would soon reverse its rate hike campaign failed to pay off. A series of surprisingly strong economic data seriously dampened expectations that the Fed would cut rates later this year, which had become the prevailing view. An astonishingly strong jobs report for January set the tone for the month, and inflationary pressures, while slightly lower, remained elevated, while retail spending remained strong.
This sparked a partial unwind of the broad January rally. The S&P 500 fell 2.4% on a total return basis during the month, while the Dow Jones returned negative 3.9%, erasing all of January’s gains. The tech-heavy NASDAQ fared better, off just 1%, which was curious given that index’s higher valuation. Typically, more expensive, longer-duration assets feel the effects of higher interest rates more than less-expensive assets. Perhaps this part of the market has more fully incorporated the likelihood of “higher for longer” interest rates, given its 2022 drubbing (-32.5%).
Growth stocks bested value stocks for the second month in a row. While perhaps two months does not necessarily a trend make, generally speaking, this would be positive news for markets because growth outperformance can portend an advancing market, while value outperformance is often associated with down markets, such as last year’s. On the other hand, with short-term interest rates this high, it’s difficult to wager aggressively that growth stocks, or even stocks in general, can meaningfully outperform bonds in the very near term—earnings yields (the inverse of price/earnings ratios) are not meaningfully above Treasury yields.
February was particularly tough for fixed income investors; while January 2023 was the best January in three decades for global investment-grade bond investors, February turned out to be the worst February over the same period. The shift in policy expectations hit the bond market hard, with two-year Treasury yields (which move the opposite way of prices) leaping to their highest levels since 2007. The part of the yield curve between the two-year and the 10-year Treasuries inverted to levels not seen in four decades, strongly suggesting an economic slowdown.
While a slowdown may loom, the continued stream of strong economic data shows that recession fears may have been premature. The Fed is basically standing on the brakes of this economy, and it has not shown signs of broad economic weakness.
Lastly, just because we have a natural tendency to focus on just what’s happening domestically, we should note that international stocks also reversed last month (-3.5%) after having been on an absolute tear since the end of the third quarter last year (+23.6% through 1/31). International performance had lagged domestic performance for years despite a huge valuation gap. Higher domestic interest rates tend to boost the US dollar, which hampers international stock performance on a relative basis. As interest rates normalize, this is an area worth watching closely.
Speaking of watching closely, does anyone know what happens when a nervous groundhog sees a Chinese balloon? Gosh, wouldn’t it be embarrassing if it turns out we shot down Punxsutawney Phil’s weather balloon? Let’s hope not for everyone’s sake, especially Phil. He had a particularly rough month.
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