There may be a mild recession or a downturn that affects different parts of the economy, but fears of economic turmoil have not materialized just yet. US GDP grew 2.9% in the fourth quarter, unemployment has stayed historically low, and consumer spending is resilient (though softening). The more hopeful view might be dampened by the continued and steep deceleration of real estate, which is a critical component of economic growth.
Investors were hopeful about valuations and inflation looking to be on a decreasing trend, which boded well for small-cap stocks (+9.7 percent), which are often more vulnerable to changes in inflation and economic development. Large-cap stocks in the US were also positively trending. That being said, defensives, which had a solid 2022 overall, failed to deliver this month, with utilities, healthcare, and consumer staples all down.
Rebalancing to maintain diverse allocations amid market instability is crucial, since both developed and developing markets have outperformed the US over the previous three months, with developed markets increasing by 20.4% and emerging markets by 22.2%, respectively. The factors working in favor of international stocks include a decline of 11% in the value of the dollar since September, cheaper relative valuations, and indices that have reduced exposure to technology and consumer discretionary.
Both taxable and tax-exempt bond prices rose by 2% to 3% in January as bond market participants began to factor in the possibility that the Federal Reserve might start to slow down the rate at which it rises interest rates. Despite indicating that more rate rises are probable, the Federal Reserve only raised rates by 0.25% at its meeting on February 1st, after six consecutive hikes of at least 0.50%.
Although public real estate investment trusts (REITs) were boosted by a more optimistic economic forecast, redemption demands have plagued the private real estate market, and the industry is preparing for further hardship. The infrastructure sector has been very strong, with pipelines leading the way with a 6.5% increase, thanks to the federal government's infrastructure expenditure.
While other asset classes fell in value in 2022, alternatives maintained their own and produced average returns. Hedge funds and other alternative assets lagged behind other asset classes in January due to their average performance. While hedge funds were mostly unchanged, private real estate and private equity eventually began to show signs of the decline that conventional assets endured throughout the majority of 2022.
For the financial markets, January has always been a month of rebirth. Even though the "January Effect" has been minimal or nonexistent in recent years, the month has been generally positive. This could be due to new investment following the year-end clearing of financial ledgers, the use of bonuses, the unwinding of tax trades, or any of a number of other reasons.
Is there hope for the remainder of 2023 after a strong start? I don't think so, even if the market mood has been lifting as of late. Based on past experiences, it is unlikely that the Federal Reserve will be able to reduce inflation without causing significant economic harm. However, as of one month into the year 2023, the gloomy economic forecasts have not come to fruition.
People in the United States aren't as flush with cash as they were after receiving stimulus payments. Consumers, however, keep spending, using both savings and borrowed funds from credit cards. There are a lot of job vacancies and the unemployment rate is around 3.5%, so long as the labor market doesn't significantly worsen, the economy can keep moving ahead.
Having said that, we still have a way to go. Since the Federal Reserve began raising interest rates in March 2022, the effects have taken at least a year to materialize. When the Federal Reserve stops raising interest rates and the market hits bottom, the US economy usually goes into recession. Given the lag in effect, the Federal Reserve has enough chance to keep pushing rates higher, maybe beyond the economic breaking point.
It's also possible that a slump in corporate profits is about to happen. With no increase in corporate profits anticipated for 2023 and a decrease of roughly 5% for Q42022 compared to Q2021, profit predictions for 2023 are falling. Not much has changed so far in the reporting season; nevertheless, fewer firms are exceeding projections (70% vs. the 77% standard) and an overwhelming majority of executive teams have provided negative outlooks (88% vs. 59% on average over the last five years).
We noted in our January Commentary that the geopolitical climate has shifted, and that this would have an impact on markets and economies. We now anticipate global cooperation to be on the slide, with open confrontation the worst-case scenario. Investors should be ready to capitalize on opportunities brought about by increased volatility in response to a shift in the market regime, rather than relying on the relatively stable markets of the last few decades, which were made possible in part by the "peace dividend" and globalization.