Our Top Market Takeaways for February 2, 2024.

Forgive us for feeling like we are in our own version of Groundhog Day.

This week, investors overinterpreted the tea leaves that Jay Powell and the Federal Reserve left after their meeting, a shocking regional bank earnings report revived worries over the sector and the 49ers are going to play the Chiefs in the Super Bowl. We haven’t even mentioned tech’s continued rise, or the likely election showdown between former President Donald Trump and current President Joe Biden.

But instead of wallowing in the same debates, we wanted to embrace the feeling of déjà vu to see if we could learn anything from the past. Here is what we found.

1. Strong starts tend to signal more strength ahead

When all was said and done, January ended with a nearly 2% return for U.S. stocks. While one month will never define a year, history suggests that starting strong is much better than not. Going back to 1950, years with a positive January usually see rallies of almost 17% and end with a gain nearly 90% of the time. When January is negative, the results are much worse. In that scenario, the S&P 500 has seen an average full year decline of about 2% and has been positive only 50% of the time.

Of course, January continued strong momentum for markets in November and December. In fact, the S&P 500 gained over 15% in those three months. Also since 1950, the average return 12 months after a rally like that is also 17%, much higher than the average 12 month return of 9% for all other periods. No analog is perfect, and markets aren’t dictated by averages, but these observations suggest that investors haven’t missed the rally.

Tying that to our view on markets this year, we expect more gains ahead. Disinflation has more room to run. Earnings growth is just getting going, from big tech and other sectors alike (this week was case in point). And soft landings tend to be a pretty good time to invest.

2. When the Fed cuts, assets tend to outperform cash

Indeed, the key reason for our optimism this year is not counting stats like the ones above. It is our understanding of what is likely to happen as central banks lower interest rates amidst a resilient economic backdrop. After the Federal Reserve’s meeting this week, Chair Powell acknowledged that it is very likely that policymakers cut rates this year, potentially as soon as May.

To get a sense for what we should expect during a rate cutting cycle, we looked at every one since the 1970s. The first pattern that became clear was that core fixed income outperformed cash in almost every instance. That makes sense because core bonds offer investors the opportunity to lock in yields instead of being at the mercy of cash yields as the Fed lowers rates. For stocks, you need to go one level deeper. If the Fed is cutting rates to support the economy, stocks are probably not doing very well. But if the Fed is cutting rates outside of recession, stock returns have been exceptional: just over 30% on average across the instances we identified.

3. Regional bank stress is a risk, but probably not for the broader economy

The fly in the ointment this week was the regional banks. The lender that purchased Signature bank during last spring’s turmoil shocked investors by increasing their allowance for loan losses and slashing their dividend. That stoked a vicious approximately 9% sell-off in regional bank shares that were finally starting to feel more comfortable as the Fed starts to ease up on interest rates.

As we noted last year, small banks are also much more exposed to commercial real estate loans that were underwritten in a very different low interest rate environment. In our outlook, we wrote about how stress in regional banks and commercial real estate was likely to percolate throughout the year, despite the Fed’s pivot to easing. We believe such stress poses a risk to our outlook, but our experience from last year suggests that this particular economic cycle is not very sensitive to regional bank lending, and the Fed has set the precedent that it would do what it takes to avoid worst case outcomes.

For now, we think certain investors can earn a premium for providing capital in these areas where it is still scarce.

4. Markets tend to care more about fundamentals than elections

If we do end up with a Biden versus Trump election contest, it will be the first time since 1892 that both candidates of the two major parties have already served as president (back then, it was Cleveland versus Harrison). For markets, that means we already have an initial sense for potential policy proposals.

Taking cues from prior campaigns and time in office, former President Trump may look to extend his tax cuts due to expire next year, explore further de-regulation, push trading partners on their terms (whether that be China, Mexico, Canada, European allies, or Iran), challenge some of the tenets in the Inflation Reduction Act (especially around green energy), and up spending on defense (but likely with less aid to Ukraine). Another term from President Biden may also seek to increase government spending (but more so around the energy transition) and stay tough on China. But he’s likely to be tougher on taxes, easier on immigration policy and more supportive to Ukraine aid.

That said, the race is still nine months out, with ample time to evolve, and getting policy proposals through also depends on what happens with Congress. For what it’s worth, stocks had strong, above-average runs in both the years that Biden and Trump were elected – a nod to our view that the economic backdrop tends to matter more.

5. Stocks like both the 49ers and the Chiefs

Super Bowl LVIII is almost here, and it’s another rematch of the San Francisco 49ers and the Kansas City Chiefs. We won’t give our pick to win the title, but stocks at least seem to slightly favor the 49ers. Looking back at all 22 Super Bowl winners, the S&P 500 has rallied almost 20% on average in years that the 49ers have won (the third best, behind the Buccaneers and the Steelers). That said, markets seem to like the Chiefs, too, with average gains of 13.5% in years they’ve won. Best of luck to both teams next weekend.

All market and economic data as of 02/02/2024 are sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

DISCLOSURES

Index definitions: 

Bonds are subject to interest rate risk, credit, call, liquidity and default risk of the issuer. Bond prices generally fall when interest rates rise.

The price of equity securities may rise or fall due to the changes in the broad market or changes in a company's financial condition, sometimes rapidly or unpredictably. Equity securities are subject to "stock market risk" meaning that stock prices in general may decline over short or extended periods of time.

The information presented is not intended to be making value judgments on the preferred outcome of any government decision or political election.

The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.

Standard and Poor’s 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The index was developed with a base level of 10 for the 1941–43 base period.

The Bloomberg Eco Surprise Index shows the degree to which economic analysts under- or over-estimate the trends in the business cycle. The surprise element is defined as the percentage difference between analyst forecasts and the published value of economic data releases. 

The MSCI World Index is a free float-adjusted market capitalization index that is designed to measure global developed market equity performance.

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• As a reminder, hedge funds (or funds of hedge funds) often engage in leveraging and other speculative investment practices that may increase the risk of investment loss. These investments can be highly illiquid, and are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important tax information. These investments are not subject to the same regulatory requirements as mutual funds; and often charge high fees. Further, any number of conflicts of interest may exist in the context of the management and/or operation of any such fund. For complete information, please refer to the applicable offering memorandum.
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