Earnings season came to an end, but the Fed stole the show

• January's financial markets performance was impressive, with the S&P 500 reaching all-time highs, fuelled by better-than-expected economic data.
• The U.S. Federal Reserve maintained its interest rates, with Chair Powell indicating potential rate reductions later in the year, but apparently unlikely in March.
• Earnings from Microsoft and Alphabet exceeded expectations but faced declines due to high market expectations.

We can all agree that January went better than expected. The S&P 500 hit multiple all-time highs towards the end of the month, and both Europe and Canada performed well. Economic data generally outperformed expectations, fuelling equity gains from late 2023. Nonetheless, geopolitical tensions (notably those due to Houthi rebel attacks on commercial shipping in the Red Sea) and a reduction in expectations for immediate rate cuts dampened some market segments.

We also saw continued optimism for a soft economic landing. U.S. economic indicators contributed to this outlook, such as strong fourth-quarter gross domestic product (GDP) growth and stable unemployment rates, alongside positive consumer sentiment. The eurozone also avoided a recession in the fourth quarter, supporting international equity gains. However, the rally in equities was still quite narrow. Some sectors and regions (like Chinese equities and regional bank stocks) underperformed due to various pressures.

This week saw the U.S. Federal Reserve (the Fed) maintain its interest rate range at 5.25-5.5%, aligning with market expectations. In his prepared commentary, Chair Powell suggested that the current policy rate might represent the apex of this tightening cycle, as we’d all already guessed some time ago. He hinted at the potential for rate reductions “some time this year", contingent on economic developments aligning with forecasts. Despite speculation, Powell downplayed the likelihood of a rate cut in March, labelling it as unlikely. He emphasized the decision would hinge on future economic data, expressing skepticism about the Fed's readiness to commit to a cut by March due to the uncertain economic landscape. As you can guess, the stock markets did not like that. Surprisingly, however, the bond market appears to be calling his bluff, and while odds of a March cut have declined, overall cut expectations for the year did not change substantially.

After highly anticipated earnings announcements, shares of Microsoft and Alphabet (Google) fell, despite both companies exceeding expectations on both revenue and earnings. Microsoft's decline was attributed to increased costs associated with artificial intelligence development, while Alphabet suffered from a shortfall in advertising revenues. Analysts have pointed out that the weaknesses observed in Alphabet (GOOGL) and Microsoft (MSFT) stocks are largely due to inflated market expectations, rather than their actual performance. This is because the benchmark for technology sector earnings had risen significantly at the onset of the fourth-quarter earnings season, driven by exceptionally strong reports from other tech giants, who drove the bar higher.

Despite terrible regional surveys all month long, somehow the national ISM Manufacturing Index showed strong improvement in January. While it remained in contraction territory for the 15^th consecutive month, the index increased to 49.1 from 47.1, surpassing the forecasted 47.2. This uptick was primarily driven by a significant 5.5-point increase in new orders, which rose above the neutral 50 mark to 52.5, suggesting a rebound in demand. Additionally, customer inventories decreased to 43.7 from 48.1, marking the lowest level since October 2022. This reduction in inventories might signal a potential phase of restocking in response to the renewed demand reflected in the rise of new orders.

Listen to this week’s podcast for further insights.