January 2023 Market Lookback

After a tough end to 2022, 2023 got off to a hot start. Economic activity & labor market data pointed to resilient consumer spending & demand, while inflation data continued to cool. Stocks picked up steam midway through the month, led by pockets of the market that struggled the most last year. Treasury yields moved down throughout the month, weighing on the strength of the US dollar and boosting international stocks in the process.

Macro

•   GDP grew 2.9% in Q4 2022, with weak residential investment being offset by government & consumer spending in addition to inventories growth.

•   223K jobs were added in December, the 9th straight above-consensus estimate print.

•   The Dec ISM Services PMI came in at 49.6, well below the consensus estimate of 55.0 & the first contractionary print since May 2020.

•   Dec CPI was in-line with expectations on both a headline & core basis, at 6.5% & 5.7% y/y and −0.1% & 0.3% m/m, respectively.

•   In addition to industrial production declining 0.7% in December, November was revised down from -0.2% to -0.6%.

Equities

•   The most high-octane parts of the U.S. market led to start 2023, with the top quintile of volatile stocks outperforming the bottom quintile by 20%.

•   Bottom-up estimates for the S&P 500 EPS for 2023 declined from $230 to $225 in January.

•   International stocks outperformed U.S. stocks on the back of an improving global growth outlook & weaker U.S. dollar.

•   Developed international market funds saw $5.7bn in net inflows in Jan, the most since Jan 2022, and emerging market funds saw $6.8bn in net inflows, the most since Mar 2022.

Fixed Income

•   Beginning the month at 3.87%, the 10-Yr Treasury yield fell as low as 3.32% on recession fears before rebounding to end the month at 3.53%.

•   Option-implied Treasury volatility, as measured by the MOVE Index, declined to its lowest level since June 2022.

•   After oscillating around 500bps in November & December, HY bond spreads narrowed to 457bps, their lowest level since Aug 2022.

Crypto

•   Bitcoin’s price return of 38.8% was its best month since it returned 40.4% in Oct 2021, while Ethereum’s return of 31.5% was its second-best month since then.

Sold for the Taxes, Bought for the Gains

An already painful sell-off in 2022 seemingly accelerated to finish the year, with highly shorted stocks falling 20% in December alone. Tax-loss selling likely played a role in the pull-back, as negative return years generally amplify the tax benefit from locking in losses.

The flipside of this is that engaging in tax-loss selling means having more dry powder to deploy, either in other assets or in the same ones (after waiting 30 days to be clear of wash-sale rules). Against that backdrop, stocks’ strong January was likely emboldened by, if not driven by, cash re-entering the market after harvesting 2022 losses. Heavily shorted stocks surged over 19%, and many industry groups & sectors that underperformed most in 2022 outperformed to start the year. Of course, the raft of econ data pointing to disinflationary pressure can’t be ignored when explaining the ignition of animal spirits in January either. That the disinflationary pressure is becoming clear with little-to-no sign of weakening in the labor market added to the market euphoria.

Margin Compression: Coming to a Company Near You

It remains to be seen whether the disinflationary environment that econ data points to will actually be good for stocks later in the year. As background, research from the Economic Policy Institute last year indicated that nearly 54% of the inflation in the nonfinancial corporate sector during 2020 & 2021 resulted in higher profit margins.

But since peaking in Q1 2022, margins have been shrinking. We’re now entering a period where revenue growth is expected to be lower than earnings growth, with the y/y comps for both likely to get more negative as the quarters roll on. A period of below-trend growth to allow supply and demand to get into better balance is what the Fed has said it’s aiming for, yet sticky wage growth & a still-strong labor market could keep cost pressures elevated in that sort of environment.

If we trust the Fed won’t give up on its mission of restoring price stability, then the way inflation came onto the scene might be the way it exits—with margin compression & weaker corporate earnings.

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