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Market Commentary
Market Commentary – January, 2024
The Size Divide
The U.S. economy grew by an annualized 3.3% in the fourth quarter, far outpacing the expected 2.0%
Overview
Markets began 2024 with mixed results. Despite the S&P 500 reaching a new all-time high on January 19, the last day of January was the worst day for the S&P 500 since September 2023. That was also the day of the Federal Open Market Committee meeting when Federal Reserve Chairman Jerome Powell erased any hopes of a March interest rate cut. U.S. large cap stocks, as proxied by the S&P 500, ended January up 1.7%. U.S. small cap stocks, as proxied by the Russell 2000, ended the month down 3.9% as hopes of a March interest rate cut dwindled. After an impressive turnaround in the fourth quarter that broke a two-year downward trend, U.S. intermediate-term bonds started the year relatively flat, ending January down 0.3%.
Preliminary estimates showed that the U.S. economy grew by an annualized 3.3% in the fourth quarter of 2023, far outpacing the expected 2.0%.1 Bolstered by robust economic growth and stock market gains, consumer confidence surged in January. The University of Michigan’s Consumer Sentiment Index recorded the largest positive two-month increase since the 1990s, jumping from 61.3 in November, to 69.0 in December, and climbing further to 78.8 in January.2 The Conference Board’s Consumer Confidence Index climbed to a two-year high in January as expectations for lower inflation, lower interest rates, and a robust labor market boosted sentiment.3 Inflation expectations eased in January, as one-year expectations declined to 2.9% (from 3.1% in December) and longerterm expectations dropped to 2.8%.2
The quit rate declined to 2.2%, a level not seen since late 2020
The labor market remained resilient throughout 2023 and into the first month of the new year. The unemployment rate held steady in January, at 3.7%, while the U.S. economy added 353,000 new jobs over the month, far outpacing the expected 170,000.4 Job openings rose to 9.02 million in December, reaching their highest level in three months.5 However, the labor market may be cooling. The quit rate declined to 2.2%, a level not seen since late 2020 and a potential sign of slowing wage growth.5 Further, Americans are still getting laid off—particularly those working in the technology sector. Over the past month alone, Alphabet, Amazon, Microsoft, Citigroup, and Wayfair (to name a few) have all announced job eliminations.6,7 Earlier in January, Microsoft announced that it will let go of 10,000 employees as it braces for slower revenue growth, and it announced on January 25 that it will lay off 9% of its gaming division, less than three months after its acquisition of Activision Blizzard.8,9 PayPal also announced on January 30 that it plans to reduce its workforce by 9% and will be cutting 2,500 jobs in the coming months.10
Treasury expects to borrow $760 billion in the first quarter of 2024, which outpaces several historic full-year issuances
On January 29, the U.S. Department of the Treasury announced its quarterly borrowing estimates. At nearly $2.4 trillion, Treasury issuance in 2023 was the second highest on record, behind only 2020. Treasury expects to borrow $760 billion in the first quarter of 2024, which outpaces several historic full-year issuances and the annual borrowing average of $721 billion since 2000.11
The FOMC met for the first time this year at the end of January and held rates steady at 5.25% – 5.50%, as was widely expected. Expectations for interest rate cuts in 2024 had increased since December 12, when Fed Chair Powell first alluded to the possibility. As of the end of January, markets were still pricing in the equivalent of six rate cuts this year. The December 2024 Fed funds rate is expected to be 3.9%, even though the possibility of a March rate cut all but evaporated during the post-FOMC press conference.12,13
As of the end of January, markets were still pricing in the equivalent of six rate cuts this year
Also in January, the Chinese government announced a series of economic stimulus plans to boost its slowing economy. These included lowering the amount of cash reserves that Chinese banks must hold, which should free up more cash for these banks to lend.14 On January 25, the government also announced a $278 billion package aimed at stabilizing Chinese markets.14 As a result of these efforts, during the last week in January, Chinese equity funds experienced their largest inflows of money since 2015.15
The new year has brought new concerns for smaller companies, as hopes for a March interest rate cut diminished
The Size Divide
Throughout 2023, U.S. small cap stocks were plagued by recession worries and elevated interest rates, which have increased borrowing costs and are expected to further impact them as debts mature in the upcoming years. However, the fortunes of small caps improved dramatically in December, buoyed by growing optimism over potential rate cuts. This optimism propelled U.S. small cap stocks to gain 14.0% during the fourth quarter, surpassing U.S. large cap stocks, which ended the quarter up 11.7%.
However, the new year has brought new concerns for smaller companies, as hopes for a March interest rate cut diminished. Consequently, U.S. small cap stocks ended January down 3.9%, lagging large cap stocks’ 1.7% gain. Moreover, as the fourth-quarter earnings season unfolded, small companies guidance has been revised downwards more substantially than their larger counterparts, signaling caution and perhaps even fear about the near-term outlook.16 Interest rates play a critical role in U.S. small cap stocks’ returns given these companies’ high levels of indebtedness. Approximately 40% of the Russell 2000 is unprofitable, and many small cap companies have large debt burdens and high borrowing costs.17 Given that interest rates remain at multi-decade highs, these companies may have to refinance their debt burdens at much higher rates. As a result, projections for the interest expense of Russell 2000 companies have risen to over 30% of EBITDA (a measure of a company’s operating performance, representing its earnings before interest, taxes, depreciation, and amortization).17
Despite these concerns, investors are still the most bullish on U.S. small caps they have been since June 2021. According to Bank of America, investors expect small cap companies to outperform large cap companies over the next 12 months.18 This sentiment might shift, however, as earnings season progresses. Nevertheless, small cap stocks tend to exhibit cyclical performance characteristics and continued economic growth, or even a potential reacceleration, could position profitable small caps quite favorably.
Most stock market gains over the past year have been driven by a few mega-cap companies, notably the “Magnificent Seven”: Microsoft, Amazon, Apple, Alphabet, Meta, Nvidia, and Tesla. Nvidia has been leading the way, ending January up 27.8%, followed by Meta, which ended the month up 14.0%, and Microsoft, up 8.8%. Amazon Web Services (AWS), a subsidiary of Amazon that offers cloud services such as computing power, storage, and databases, generated $91 billion in revenue in 2023, higher than the revenue of 468 companies in the S&P 500.
Amazon Web Services generated $91 billion in revenue in 2023, higher than the revenue of 468 companies in the S&P 500
After reporting its fourth quarter earnings, Meta’s market cap grew by $197 billion in one day—the largest single-day gain for any company in history
Over the past 12 months, AWS revenue alone exceeded the revenue of Nvidia ($45 billion), Visa ($33 billion), Disney ($89 billion), Nike ($51 billion) and Wells Fargo ($82 billion), to name a few. Over the past decade, AWS revenue has grown at an eye-popping annualized average of 40%. But Amazon isn’t the only magnificent company enjoying remarkable outcomes. After reporting its fourth-quarter earnings, Meta’s market cap grew by $197 billion in one day—the largest single-day gain for any company in history.19
One formerly magnificent company has seemed far less magnificent in recent months. Tesla appears to have been ousted from the group due to its weak revenue, negative outlook, and leadership challenges that have plagued the company.20,21 As a result, Tesla ended January down 24.7%. Apple may also be losing favor with investors as the company has struggled to rekindle the impressive historic growth rates that drove it to become one of the world’s largest companies. While its prospects may change, Apple ended January 0.7% lower, after reporting trailing 12-month revenue growth of 2.8% and earnings growth of just 0.3%.
The remaining 494 companies in the S&P 500 are expected to report an earnings decline of 10.5%
Nevertheless, several members of this group, including Alphabet, Microsoft, Meta, and Nvidia, enjoyed record-high share prices in January. The “Magnificent Six” stocks (i.e., excluding Tesla) are projected to report a combined year-over-year earnings growth of 53.7% for the fourth quarter of 2023.22 In contrast, the remaining 494 companies in the S&P 500 are expected to report an earnings decline of 10.5%, which speaks to the magnitude of influence that these mega-cap companies have had on the stock market. Overall, earnings for the S&P 500 are projected to rise by 1.8% for the fourth quarter.22,23
While it may be tempting to dismiss the recent divergence between all small and big companies, investors do appear to be discerning winners from losers and the impressive earnings growth of the large caps is a far cry from the last period in history with a similar ‘size divide’—the Tech Bubble. Only time will tell whether small cap stocks will emerge triumphant once the Fed starts cutting rates or if the mega-cap companies will continue to dominate.
Crude oil surged to $78 per barrel on January 26, propelled by stronger-thanexpected U.S. GDP growth
Markets
January saw very mixed performance across various asset classes. As discussed above, U.S. large cap stocks were the top performers, while emerging and frontier market stocks were the worst performers, ending the month down 4.6%. U.S. intermediate-term bonds ended January down 0.3%, outperforming international developed market bonds, which ended the month down 3.0%. After a stellar 2023, midstream energy started 2024 on the back foot and ended January down 2.2%.
The 10-year Treasury yield climbed higher in January, reaching a high of 4.2% on January 24, following remarks by Fed Governor Christopher Waller and Atlanta Fed President Raphael Bostic on taking a slower approach to interest rate cuts than markets initially had hoped for. During his speech at the Brookings Institute on January 16, Governor Waller commented that:
“In many previous cycles, which began after shocks to the economy either threatened or caused a recession, the FOMC cut rates reactively and did so quickly and often by large amounts. This cycle, however, with economic activity and labor markets in good shape and inflation coming down gradually to 2%, I see no reason to move as quickly or cut as rapidly as in the past.”24
In commodity markets, West Texas Intermediate (WTI) crude surged to $78 per barrel on January 26, propelled by stronger-than-expected U.S. GDP growth for the fourth quarter and news of additional stimulus and policy support from China.25 However, WTI retreated slightly in the last week of January to end the month at $75 per barrel.25 On December 26, gold closed at a new all-time high of $2,077, thanks to expectations of imminent rate cuts, but it remained above $2,000 per ounce throughout January even as rate cut expectations moderated.26
“Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names…”
Looking Forward
While investors have celebrated impressive earnings growth for a small subset of the U.S. large cap market that propelled the S&P 500 to a new all-time high, the equal-weighted S&P 500 remains about 5% below its all-time high set more than two years ago. Further, U.S. small cap stocks are currently more than 21% lower than their all-time highs, which they hit in late 2021. There’s a Wall Street adage that states that “markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names”, but given the unusual earnings backdrop that has supported this widely divergent market, investors may be understandably tempted to look past that.27
In addition to a vexing earnings backdrop, the unusual policy mix of rampant fiscal spending, combined with the expectations of easier monetary policy, may be enough to take any particularly bad outcomes off the table ahead of the election. Since investors can’t predict the future, we believe that the tried-and-true strategy of diversification remains truer than ever.
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Disclaimer
Magnus Financial Group LLC (“Magnus”) did not produce and bears no responsibility for any part of this report whatsoever, including but not limited to any microeconomic views, inaccuracies or any errors or omissions. Research and data used in the presentation have come from third-party sources that Magnus has not independently verified presentation and the opinions expressed are not by Magnus or its employees and are current only as of the time made and are subject to change without notice.
This report may include estimates, projections or other forward-looking statements, however, due to numerous factors, actual events may differ substantially from those presented. The graphs and tables making up this report have been based on unaudited, third-party data and performance information provided to us by one or more commercial databases. Except for the historical information contained in this report, certain matters are forward looking statements or projections that are dependent upon risks and uncertainties, including but not limited to factors and considerations such as general market volatility, global economic risk, geopolitical risk, currency risk and other country-specific factors, fiscal and monetary policy, the level of interest rates, security-specific risks, and historical market segment or sector performance relationships as they relate to the business and economic cycle.
Additionally, please be aware that past performance is not a guide to the future performance of any manager or strategy, and that the performance results and historical information provided displayed herein may have been adversely or favorably impacted by events and economic conditions that will not prevail in the future. Therefore, it should not be inferred that these results are indicative of the future performance of any strategy, index, fund, manager or group of managers. Index benchmarks contained in this report are provided so that performance can be compared with the performance of well-known and widely recognized indices. Index results assume the re-investment of all dividends and interest and do not reflect any management fees, transaction costs or expenses.
The information provided is not intended to be, and should not be construed as, investment, legal or tax advice nor should such information contained herein be construed as a recommendation or advice to purchase or sell any security, investment, or portfolio allocation. An investor should consult with their financial advisor to determine the appropriate investment strategies and investment vehicles. Investment decisions should be made based on the investor’s specific financial needs and objectives, goals, time horizon and risk tolerance. This presentation makes no implied or express recommendations concerning the way any client’s accounts should or would be handled, as appropriate investment decisions depend upon the client’s specific investment objectives.
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Definitions
Asset class performance was measured using the following benchmarks: U.S. Large Cap Stocks: S&P 500 TR Index; U.S. Small & Micro Cap: Russell 2000 TR Index; Intl Dev Large Cap Stocks: MSCI EAFE GR Index; Emerging & Frontier Market Stocks: MSCI Emerging Markets GR Index; U.S. Intermediate-Term Muni Bonds: Bloomberg Barclays 1-10 (1-12 Yr) Muni Bond TR Index; U.S. Intermediate-Term Bonds: Bloomberg Barclays U.S. Aggregate Bond TR Index; U.S. High Yield Bonds: Bloomberg Barclays U.S. Corporate High Yield TR Index; U.S. Bank Loans: S&P/LSTA U.S. Leveraged Loan Index; Intl Developed Bonds: Bloomberg Barclays Global Aggregate ex-U.S. Index; Emerging & Frontier Market Bonds: JPMorgan EMBI Global Diversified TR Index; U.S. REITs: MSCI U.S. REIT GR Index, Ex U.S. Real Estate Securities: S&P Global Ex-U.S. Property TR Index; Commodity Futures: Bloomberg Commodity TR Index; Midstream Energy: Alerian MLP TR Index; Gold: LBMA Gold Price, U.S. 60/40: 60% S&P 500 TR Index; 40% Bloomberg Barclays U.S. Aggregate Bond TR Index; Global 60/40: 60% MSCI ACWI GR Index; 40% Bloomberg Barclays Global Aggregate Bond TR Index.