Stocks build on their year-to-date rally

Stocks build on their year-to-date rally as they finished higher for the third week in a row, supported by upside surprises in economic data, fourth-quarter earnings reports, and encouraging signs from the Federal Reserve. The S&P 500 is approximately 15.6% higher than its low level on October 12. All sectors, except for energy, utilities, and healthcare, ended the week higher. The S&P 500 Index reached an intraday high of 4,195 on Thursday, its best level since late August. Since the beginning of the year there has been a big divergence between the NASDAQ and the Dow. For the week, the NASDAQ was up 3.3% while the Dow was down 0.2%. Year to date through Friday, the NASDAQ was up nearly 14.8% compared with the Dow’s 2.4% gain. The price of U.S. crude oil fell nearly 8% for the week to around $73 per barrel—the lowest level in about a month. An increase in U.S. crude supplies was among the factors that weighed on oil prices. Treasuries ended the week mostly weaker, with the curve flattening. The yield of the 10-year U.S. Treasury bond was little changed for the week at around 3.53%. On Thursday, the yield fell to as low as 3.33%—the lowest in about five months. It rebounded sharply following Friday’s release of better-than-expected monthly job numbers. The dollar index ended the week stronger, helped by Friday’s jobs report. The Federal Reserve raised the Fed Funds target rate by 25 basis points in a move that was well preannounced by the Fed and anticipated by the markets. With the last rate hike, rates are now into restrictive territory to slow inflation. This rate hike represents a downshift from December’s 50-bp move and is 50 bps less than the four consecutive 75-bp hikes in 2022. Analysts believe that the Fed will continue increasing interest rates with two additional 25-bp hikes, a move Chairman Jerome Powell implied in his press conference. The next day, the European Central Bank, and the Bank of England both lifted their key rates by a half-percentage point. The Federal Open Market Committee’s statement changed slightly mentioning that inflation has eased somewhat but remains elevated. The statement regarding “the global health crisis as well as food and energy were contributors to inflation” was removed but the phrase “ongoing increases in the target range will be appropriate” remained in the official press release. Chairman Powell stated several times that the Fed’s job isn’t done and that the Fed will keep its strict policy to bring inflation back down to its 2% target. Analysts believe that terminal rate will be more than 5% by the first half of 2023. The January labor market report shows the economy remains too strong for the Fed, keeping the Fed on track to keep raising rates to slow inflation. Nonfarm payrolls rose significantly, adding 517,000 jobs in January, with upward revisions to prior months. The strong employment growth shows the economy isn’t to a recession yet as expected. The gain was driven by a large 54,000 increase in government payrolls, in manufacturing, leisure, retail, and professional and business services. The unemployment rate fell to a 50-year low of 3.4% in January despite an increase in the labor market participation rate. Analysts expect the employment growth to slow during the next couple of reading. More importantly to the Fed is the average hourly earnings growth which in January decreased. The decline in wage growth shows that price inflation is slowing. According to investment houses survey, net flows into global equity funds increased again in the week ending February 1st, +$16bn vs +$14bn in the previous week. Flows into global fixed income funds decreased +$8bn vs +$12bn in the previous week as flows into government funds and IG credit slowed from high levels. Despite the recent rally, analysts believe that US equities upside will remain limited from current levels and that the S&P 500 is unlikely to end the year substantially above the range of 4000-4200 because 1) valuations are elevated versus history as S&P 500 trades at 18.4x forward earnings, 2) S&P 500 earnings are unlikely to grow much this year even in the case of a soft landing, 3) alternatives investments to US equities, including cash, credit, and non-US equities, are attractive, and finally the debt ceiling deadline later this year causes uncertainty to investors. Equity and bond market volatility will remain elevated until there’s a significant and consistent decrease in inflation, and the duration of higher rates is more certain. We remain defensive in our positioning, and we’d look for opportunities to upgrade portfolios during market weakness. Within equities, we continue to favor U.S. Large Cap exposure, since China’s evolving COVID policies continue to weigh on manufacturing and growth. China's stock rally after Covid-19 easing cave in amid poor economic data. Analysts say the markets have already priced in the full impact of easing measures, and full recovery will take time. We’ve recently become more constructive on Developed International equities, as the energy recession in Europe wasn’t as severe as anticipated. In the United States, large cap equities provide an attractive blend of quality, yield and growth at a reasonable value, although at higher valuations and deteriorating earning.