Last week kicked off an intense period of macroeconomic data that started with Q4 GDP, personal income & personal spending and will wrap up with December non-farm payroll report on Friday. In between, we’ll get the Fed’s January interest rate decision, a slate of GDP readings over in Europe, quarterly earnings reports from several “magnificent 7” names, China PMI, U.S. PMI and a policy decision from the Bank of England. There’s the potential for some more volatility this week, but stock prices have kept moving higher in the lead-up and the VIX remains very subdued as it has for the past few months. It’ll likely take a big surprise from one of these reports to shake investors out of their bullish mood.
There’s a chance we get it from the Fed this week. While it’s extremely unlikely that they’ll make any changes to interest rates, it’s the language from the policy statement and indications on the direction of future policy that the market will be reacting to. The markets have backed up a bit on their ultra-dovish interest rate expectations in recent weeks. The futures market is now pricing in five hikes for 2024, down from 6-7 earlier this month, and the first hike is more likely to arrive in May, not March. That’s still more dovish than the Fed has been indicating and a Powell signal that the market’s expectations are too dovish again could be met with more selling. For now, we’ve really only seen long-term Treasuries reacting to more muted rate cut expectations (they’re down about 4% year-to-date). Equity averages, especially the S&P 500, have largely been unfazed and have been drifting higher to various degrees over the past two weeks. In 2022, the market made multiple attempts to forecast Fed dovishness and sent stocks significantly higher. In each instance, when Powell threw cold water on the idea, stocks retreated and established a new short-term low within a couple of months. Don’t be surprised if this happens again and the S&P 500 starts to retreat.
For now, market breadth is still negative and this weakness is, again, being masked by the “magnificent 7” stocks (or six if you want to drop Tesla). The Fed was trying to strike a hawkish tone even prior to entering 2024 and I don’t think any data we’ve gotten over the past month would be cause to change that position. So I think there’s more downside risk to equities than upside potential surrounding the Fed meeting this week. The labor market data at the end of the week is likely to show another modest gain in jobs that probably won’t change the narrative much. The JOLTS report showed an increase in job openings, but not the level that would spark major concern. While the Fed could trigger a near-term pullback in stocks depending on their tone, it could require a real crack in the labor market before we see a more serious correction.
This week has been all about the December GDP data and most of it hasn’t been positive. In Europe, Eurozone GDP was flat for the quarter and up a scant 0.1% year-over-year, narrowly avoiding the technical definition of a recession, but also confirming that the region’s economy is in trouble. Germany’s economy contracted by 0.2% year-over-year, but Italy and France were in somewhat better shape, improving by 0.5% and 0.7%, respectively. This does, however, confirm the idea that investors should consider becoming more selective in their geographic allocations. Countries with better economic profiles have generally seen better equity returns over the past 12 months (see Italy, Mexico, India and the United States) and with a relative dearth of positive economic stories to choose from, these markets may continue to emerge as quality-themed options into 2024.
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