Last Week in Review – January 20, 2023

Last Week In Review

Last week, the major indexes ended mixed as recession fears appeared to weigh on sentiment. The narrowly focused Dow Jones Industrial Average performed worst. It gave back a portion of its strong rally in the first two weeks of the year, while the technology-heavy Nasdaq Composite recorded a modest gain. Relatedly, dampening inflation fears helped growth stocks outperform, as the prospect of lower interest rates increased the implicit value of future earnings. Markets were closed on Monday during the Martin Luther King, Jr. holiday.

US – Markets & Economy

The week brought several additional signals that the economy slowed significantly following the Federal Reserve’s aggressive rate hikes in 2022. Most notable may have been Wednesday’s report of a 1.1% drop in retail sales in December, which was roughly triple consensus estimates. A decrease in sales at gas stations was partly at work, but Americans pulled back on sales of furniture, electronics, and other discretionary purchases. November sales data were also revised lower.

The upside of the weakening economy for investors was declining inflation pressures. The Labor Department reported that producer prices fell 0.5% in December, the most significant drop since early in the pandemic, as prices companies paid for goods, food, and especially energy recorded declines.

The week also brought news that industrial production fell by 0.7% in December, the most since September 2021, driven by a 1.3% drop in manufacturing output. For the fourth quarter, the industrial sector of the economy contracted at an annualized rate of 1.7%. Capacity utilization ended December at 78.8%, its lowest level of 2022 and well below its long-term average (79.6%) and consensus expectations.

However, the job market remained unusually tight in this environment, with weekly jobless claims falling to their lowest level since April 2022. Housing starts and existing home sales also lost a bit less than expected.

Investors also reacted to the second week of major quarterly earnings reports, although financial services firms dominated the trickle of early reports. The flow of reports was expected to pick up the following week, with companies representing roughly 27% of the S&P 500 Index’s market capitalization reporting results, up from a little over 4%. Shares in Goldman Sachs and insurer Travelers fell sharply and dragged the broad indexes lower to start trading on Tuesday after reporting earnings misses.

However, Netflix’s earnings report on Friday appeared to boost sentiment following news that it had added more subscribers than widely expected in the fourth quarter. Shares in Google parent Alphabet also pushed the broad indexes higher after the company announced plans to trim roughly 6% of its workforce.

US – Equity Market Performance

SOURCE: BLOOMBERG. THIS CHART IS FOR ILLUSTRATIVE PURPOSES ONLY AND DOES NOT REPRESENT THE PERFORMANCE OF ANY SPECIFIC SECURITY. PAST PERFORMANCE CANNOT GUARANTEE FUTURE RESULTS.

US Yields & Bonds

U.S. Treasuries posted positive returns as the yield on the benchmark 10-year note fell to its lowest intraday level in over four months before rising to the end of the week. (Bond prices and yields move in opposite directions.) Along with the week’s tepid economic data, the Bank of Japan’s commitment to yield curve control helped a rally in Treasuries on Wednesday. Meanwhile, municipals continued to enjoy ample demand in the face of limited new supply.

Light issuance also bolstered investment-grade corporate bonds, although banks quickly came to market after reporting. Conversely, new deals drove most of the sales activity in the high-yield market and were met with solid demand. The leveraged loan market was pretty quiet, although technical conditions for the loan asset class were generally supportive.

US Treasury Markets – Current Rate and Bi-Monthly Change

Interesting News Overseas

Shares in Europe weakened after European Central Bank (ECB) policymakers signaled that they would still hike interest rates aggressively, reigniting fears of a prolonged economic slowdown. The pan-European STOXX Europe 600 Index ended the week modestly lower in local currency terms. Major stock indexes were generally softer. Germany’s DAX Index fell 0.35%, France’s CAC 40 Index eased 0.39%, and Italy’s FTSE MIB Index was almost flat. The UK’s FTSE 100 Index declined 0.94%.

ECB President Christine Lagarde dismissed market speculation that a fall in energy prices would allow policymakers to slow the pace of monetary policy tightening. Speaking at the World Economic Forum in Davos, Switzerland, she said: “I would invite [financial markets] to revise their position; they would be well advised to do so.” She explained: “Inflation, by all accounts, however, you look at it, is way too high. Our determination at the ECB is to bring it back to 2% in a timely manner, and we are taking all the measures we have to take to do that.”

The minutes of the ECB’s December meeting—when the Governing Council raised key rates by half a percentage point—also suggested that future rate hikes might be higher. The minutes showed that a “large number” of members wanted to raise borrowing costs by 0.75 percentage points. These policymakers only backed the smaller increase once the remaining central bank governors agreed to maintain a hawkish stance.

Stock markets in Japan rose over the week, with the Nikkei Index gaining 1.66% and the broader TOPIX Index up 1.25%. The sentiment was supported by the prospect of China’s reopening boosting the global economy and hopes that the major central banks would slow the pace of their rate hikes amid some signs of waning inflationary pressures. Investors focused on the Bank of Japan (BoJ), which left its monetary policy unchanged at its January meeting, having surprised markets in December by tweaking its yield curve control (YCC) framework. Without further YCC modifications, the yield on the 10-year Japanese government bond (JGB) fell to 0.40% from 0.51% at the end of the previous week. The yen weakened to around JPY 129.81 against the U.S. dollar, from about JPY 127.88 the prior week, on the BoJ’s commitment to its ultra-loose stance.

There was no change in the BoJ’s monetary policy at its January meeting—it maintained its ultralow rates and left its YCC framework unchanged—as had been widely expected. Despite growing speculation about further policy change following December’s surprise YCC tweak, the cap on the 10-year JGB yield was raised to 0.50% from 0.25%.

The BoJ said that medium- to long-term inflation expectations had risen, albeit at a moderate pace relative to short-term ones, and raised its forecasts for the core CPI for fiscal years 2022 and 2023—which had also been widely anticipated. The central bank noted that risks to inflation are skewed to the upside, leaving the possibility that forecasts would be revised up at the time of the next release in April. Japan’s core CPI rose 4% year on year in December, a 41-year high, as companies passed rising costs onto consumers. Producer prices also surged over the same period.

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