US Economy Continues to Defy Expectations with Impressive 2023 Start

Monthly Client Letter
Written By Jonathan M. Elliott, CPWA®, CRPC®, CDFA®, ChSNC®, CPFA™, RMA®
Worker in a machine shop

Photo Credit: Maxime Agnelli, Unsplash

Monthly Market Summary

  • The S&P 500 Index returned -2.5% in February, giving back a portion of its January gains and underperforming the Russell 2000 Index’s -1.7% return. Cyclical sectors marginally outperformed in February, with Technology, Industrials, and Consumer Discretionary as the top three performing sectors.

  • Corporate investment grade bonds produced a -4.2% total return, trailing corporate high-yield bonds’ -1.9% total return. The negative bond returns occurred as Treasury yields increased following robust January economic data.

  • International stocks underperformed for the first time since October as the U.S. dollar strengthened. The MSCI EAFE Index of developed market stocks returned -3.1%, outperforming the MSCI Emerging Market Index’s -7.6% return.

Data Indicates the U.S. Economy is Off to a Strong Start in 2023

Based on January economic data and fourth-quarter data revisions, the U.S. economy is in a stronger position than economists forecast. Job growth was robust in January as U.S. employers added 517,000 jobs, well above the average of 291,000 jobs added each month in the fourth quarter. Consumer spending exceeded expectations in January, with retail sales rising 3% month-over-month after two consecutive monthly declines to the end of 2022. Using industrial production as a measure, manufacturing output stayed the same in January after falling in the last two months of 2022. Investors will want more proof of the economy's recent strength in the coming months, but it seems less likely that a recession will start in the first quarter of 2023.

On a related note, January’s data could strengthen the Federal Reserve’s case to maintain a tighter policy stance for longer. There are two potential investment implications. First, the Federal Reserve may keep interest rates higher for longer, meaning higher interest income for savers. Second, a more extended period of restrictive monetary policy could have a more significant adverse impact on the economy and result in slower economic growth in the coming quarters and years. Despite market expectations for the central bank to stop raising interest rates in the first half of 2023, the Federal Reserve remains a key driver in financial markets.

An Update on Fourth Quarter 2022 Earnings Season

Source: MarketDesk Research

As of February 27th, 94% of S&P 500 companies had reported fourth-quarter earnings. Blended earnings growth, which combines actual results for companies that have reported and estimated results for companies that have yet to report, is -4.9% vs. Q4 2021. If the decline holds, it will mark the S&P 500’s first year-over-year earnings decrease since Q3 2020. Quarterly earnings growth is negative, but the results are not viewed as disastrous. However, the data indicates earnings momentum may be fading in the face of persistent macro headwinds, including the Federal Reserve’s aggressive 2022 interest rate increases and rising input costs.

Our Insights

Featured
Fed Cuts Rates By Another -0.25%, But Lowers Expectations for 2025
Fed Cuts Rates By Another -0.25%, But Lowers Expectations for 2025

This week, the Federal Open Market Committee (FOMC) concluded its final monetary policy meeting of 2024 by lowering the federal funds rate by 0.25 percentage points to a range of 4.25%-4.50%. This was the third consecutive rate cut, reducing the benchmark short-term rate by a full percentage point over the year. While the rate cut was widely anticipated, the central bank adopted a more hawkish outlook than Wall Street had expected, scaling back its 2025 rate cut projections from four to two. This cautious approach likely reflects the sticky inflation readings this fall, which showed a modest uptick in price growth.

S&P 500 Sets More Than 50 New Highs in 2024
S&P 500 Sets More Than 50 New Highs in 2024

The past two years have been remarkable for investors, with the S&P 500 posting back-to-back gains of over +20%. The chart below looks at 2024’s price movement and uses yellow shading to mark the days when it closed at an all-time high. Since late January 2024, the S&P 500 has set over 50 new highs this year.

Labor and Inflation Data Give the Fed the Green Light to Cut Rates
Labor and Inflation Data Give the Fed the Green Light to Cut Rates

This week, the Bureau of Labor Statistics released the latest inflation data, following recent updates on consumer and producer prices. While November's consumer price index (CPI) and producer price index (PPI) largely met expectations, both showed persistent upward pressure, disappointing Wall Street. We anticipate the Federal Reserve will respond by lowering short-term interest rates at its December 17-18 meeting, likely by 25 basis points to a range of 4.25%-4.50%.

Jonathan M. Elliott, CPWA®, CRPC®, CDFA®, ChSNC®, CPFA™, RMA®

I am currently the Managing Partner for our independent investment advisory firm, Optima Capital Management. Together with my business partners, Todd Bendell CFP® and Clinton Steinhoff, we founded Optima Capital in 2019 as a forward-thinking wealth management firm that serves as an investment fiduciary and family office for high-net-worth individuals and families. In addition to being the Chief Compliance Officer, my role at Optima Capital is portfolio management. I have over 18 years of experience in managing investment strategies and portfolios. I specialize in using fundamental and technical analysis to build custom portfolios that utilize individual equities, bonds, and exchange-traded funds (ETFs). I began my financial services career with Merrill Lynch in 2003. At Merrill, I served in the leadership roles of Market Sales Manager and Senior Resident Director for the Scottsdale West Valley Market in Arizona. On Wall Street Magazine recognized me as one of the Top 100 Branch Managers in 2017. I am originally from Saginaw, Michigan, and a marketing graduate from the W.P. Carey School of Business at Arizona State University. I am a Certified Private Wealth Advisor® professional. The CPWA® certification program is an advanced credential created specifically for wealth managers who work with high net worth clients, focusing on the life cycle of wealth: accumulation, preservation, and distribution. In addition, I hold the following designations - Chartered Retirement Planning Counselor (CRPC®), Certified Divorce Financial Analyst (CDFA®), Certified Plan Fiduciary Advisor (CPFA), and Retirement Management Advisor (RMA®). In the community, I am a member of the Central Arizona Estate Planning Council (CAEPC) and serve as an alumni advisor and mentor to student organizations at Arizona State University. My interests include traveling, outdoors, fitness, leadership, entrepreneurship, minimalism, and computer science.

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