The week in the markets -
February 3, 2023

Will the January market rally continue?

“Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” – Sir John Templeton

This week, the U.S. Federal Reserve increased its key benchmark rate by 25 basis points, to mark its eighth consecutive rate increase. It’s easy to forget that the Fed was holding the federal funds rate at around zero as recently as the first quarter of 2022. The Fed raises interest rates when the economy starts overheating (with too much inflation) and cuts rates when the economy looks weak (with high unemployment).

Since August of last year, we’ve seen a downward trend in inflation and a decline in manufacturing and housing. Those indicators help central banks around the world determine the lending rates required to stimulate or slow down an economy, even if that means leaning into a recession. We continue to anticipate that inflation’s momentum will continue downward in the near term, with a model target of 3.5% by mid-year and potentially reaching the 2% target central banks are hoping for by 2024. That will ultimately reassure the Fed, so it can start to ease the pace of increases or even start lowering interest rates.

Earnings season for Q4 2022 and the calendar year-end has already started, and we are seeing a mix of favourable and unfavourable results. Many companies missed their earnings growth targets but were still profitable, even as margins got tighter. However, the recent rebound in markets in January could be seen as a sign that a soft landing may be priced into the markets. That being said, there is still potential for volatility, as more companies adjust their expectations, and we see price discovery across markets.

Even in the face of strong outperformance of international stocks, we believe there are still opportunities in these markets at current valuations. Equities enjoyed a very strong start to the year.  Ending January 31, the S&P 500 Index gained 6.2% (in U.S. dollars), the S&P/TSX Composite Index gained 7.1% (in Canadian dollars), the MSCI EAFE Index gained 8.1% and the MSCI EM Index gained 7.9% (both in U.S. dollars), all excluding dividends. In addition, bonds have had a strong start to the year as yields have fallen, with the FTSE Canada Universe Bond Index gaining 3% in January alone.

An updated report on jobs growth in the U.S. backed up the Fed’s decision to continue raising rates. Jobs in manufacturing increased in 2022 overall, compared to a near equal loss in construction jobs (likely due to a slowdown in housing starts since peaking in April of 2022). Since then, housing starts have fallen over 20% as of January 31, 2023. Many macro-factors are working in favour of investors, such as China dropping its zero-COVID-19 policy and reopening over the past several weeks, as well as energy prices (oil and natural gas) dropping. Energy can be a tax on consumption and has been off its peaks of last year. Inflation is abating, and interest rate hikes are at or near their end. Europe has enjoyed recent economic surprises to the upside.  And while we still see risk of a recession for the U.S. and Canadian economies in 2023 or 2024, the best-case scenario of a soft landing may play out.

Monetary policy is an art and a science, like much else in life.