United States

Equity markets rally to all-time highs as the economy remains resilient 

In a continuation of 2023’s strong year-end rally, the S&P 500® reached a new all-time high in late January, ending the drawdown that began more than two years ago. Investors wrestled with expectations for a monetary policy pivot as inflation continued to moderate and the U.S. consumer remained resilient, supported by a healthy labor market.

The narrow, large-cap market leadership that plagued most of 2023 resumed in January as the S&P 500 rose 1.7%, while the S&P 500 Equal Weight index declined 0.8%. The S&P MidCap 400® and Russell 2000® both declined as well. From a style perspective, the Russell 3000® Growth outperformed the Russell 3000® Value by more than 200 basis points (bps), marking the second-widest outperformance by growth in the past six months.

Economic data continues to be robust. The payroll report released on February 2 showed the economy added 353,000 net new jobs, blasting past the consensus expectation of 185,000. Additional metrics also came in better than expected. The unemployment rate held steady at 3.7% and average hourly wage growth of 4.5% remains well-above the Consumer Price Index (CPI) level, boosting consumer confidence. The latest CPI reading rose modestly to 3.4% in December, up from 3.1% in November, as service inflation persisted and declines in goods and energy inflation eased. However, Core CPI (which excludes food and energy) nudged lower to 3.9%, the lowest level since May 2021. Similarly, the Federal Reserve’s (Fed’s) preferred inflation indicator, core personal consumption expenditures, continued to moderate, falling from 3.2% to 2.9%, marking its lowest level since April 2021. While these inflation measures largely continued their downward trajectory, they remain above the Fed’s 2% target.

In our view, tight labor markets and positive real wage growth have fueled consumer spending. Personal consumption helped lift the initial reading of fourth quarter annualized GDP to 3.3%, well above the consensus estimate of 2.0%. This marked the sixth consecutive quarter that U.S. economic growth has increased above the 15-year average of 1.9%. Consumers have proven resilient despite high interest rates and elevated inflation.

While elevated inflation, high borrowing costs and weakness in Europe and China have served as material headwinds for manufacturing activity over the last few years, data in January pointed to signs of a potential recovery. The S&P Manufacturing Purchasing Managers Index (PMI) came in well-above expectations and entered expansion territory for the first time since April 2023.

Following the January Federal Open Market Committee meeting, Fed Chair Jerome Powell reaffirmed during his press conference that the committee’s rate hiking cycle is complete, but that it does not anticipate easing interest rates until inflation moves sustainably toward its 2% target. Meanwhile, investor optimism for significant, near-term fed funds rate cuts waned during the month on the back of strong economic data (Figure 1). We believe absent a moderate-to-severe recession, the Fed will take an even more gradual approach to easing policy than consensus expects. 

Figure 1. Implied Probability Of Interest Rate Cuts
 Market pivots from expectations of imminent cuts

Source: As of 1/31/2024. Source: Bloomberg L.P.

 

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During the month, interest rate volatility, as measured by the ICE BofAML MOVE Index, decreased. The index reached its lowest level since September 2023 as concerns around a potential government shutdown subsided when Congress extended its continuing resolution into March. Core fixed income was down slightly for the month as interest rates increased modestly; however, the Bloomberg U.S. Aggregate Index remains in the drawdown that began in August 2020. We expect interest rates will remain highly volatile due to several factors, including the outsized federal deficit and uncertain path of monetary policy.

With over a quarter of S&P 500 constituents having already reported fourth quarter earnings, the blended earnings growth rate (consensus estimates combined with actual results) of 0.1% remains below the consensus estimate of 1.5% at the start of earnings season. Should earnings results continue to fall, the fourth quarter would mark the fifth consecutive quarter of negative earnings growth when excluding the “Magnificent 7” companies, which have largely contributed to the positive headline earnings growth rate.

Valuations pushed higher in January as equities rallied and earnings estimates declined. The S&P 500 forward price-to-earnings ratio rose to 20.1 times (x), surpassing its 19.6x peak in July 2023. While earnings revisions to full-year 2024 estimates have fallen relative to the start of the year, given leading economic indicators still point toward a business cycle contraction, we believe the 2024 earnings growth estimate of 11% remains overly optimistic. As such, valuations are at rich levels, reflecting consensus expectations for lower interest rates and an economic “soft landing” in 2024.

Developed International 

Headwinds persist as investors focus on central bank policy

Developed international market investors began the new year with expectations that with inflation subsiding, the monetary tightening cycle was peaking and rate cuts might be around the corner.  The MSCI World ex-USA Index ended the month up 0.4%, led by equities in Japan and growth equities overall.

While Japan’s economy has been mired in low growth for years, its equity market is a juggernaut of innovative growth across several sectors. January performance was led by automobile companies in the Consumer Discretionary sector and Industrials as earnings came in better than expected. As a result, the MSCI World ex USA Growth Index outperformed its Value counterpart for the fifth consecutive month.

On a macro level, there remain key differences between major developed international economic blocks. The Eurozone is in broad stagnation as it faces stiffening energy competition, rising risks of supply chain disruptions from the Red Sea turmoil and a continuing Russia-Ukraine war at its doorsteps. That said, we are cognizant of several tailwinds: the labor market remains tight, real wage growth is positive and the European Central Bank has shifted to a more dovish tone on monetary policy.

In the United Kingdom (U.K.), the services sector, which accounts for most of the country’s economic output, is showing signs of recovery. The Purchasing Manager’s Index for services is now firmly in expansion territory at 53.4, above the neutral level of 50. That said, with trade disruption in the Red Sea showing no signs of abating and still-elevated services inflation, the Bank of England has yet to abandon its tightening bias (Figure 2).

Figure 2. Leading Economic Indicators 
Diverging services inflation in the U.K. and Euro Area


Source: As of 1/31/2024. Source: Bloomberg L.P.

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Diverging monetary policies between the Fed and the Bank of Japan is causing Japan’s equity returns to rely on currency effects, rather than the fundamentals of corporate earnings growth. While falling real wage growth weighs on consumers, ongoing yen weakness is also making imports more expensive. 

Emerging Markets

China contributes to a challenging month for equities

Emerging markets (EM) started 2024 with their worst monthly return since August 2023. Equities in China and South Korea, which constitute almost 40% of the index, were both down approximately 10% in January. India, which late last year became the second largest country in the MSCI Emerging Markets IMI index behind China, was one of the few countries to deliver a positive return as it continues to benefit from companies exiting China.

In China, retail sales, industrial production, GDP growth and PMI data all showed positive momentum in January. One notable exception was real estate, which remains challenged. Continued trouble in the sector prompted the People’s Bank of China to surprise investors with a 50 bp cut to their required reserve ratio. While this action helped stabilize China’s equity market in the last week of the month, we believe structural issues in the real estate sector remain. Given China’s underperformance of late, equity valuations now stand at historically low levels. Priced at less than 10x expected 2024 earnings, these stocks are trading at about half the valuation of the S&P 500, all despite having a better earnings outlook than many other key equity markets.

January’s highly anticipated presidential election in Taiwan ultimately proved to have a fairly muted market impact. Voters re-elected the incumbent Democratic Progressive Party candidate. However, the opposition Kuomintang, which has a focus on reunification with China, narrowed its gap from prior elections, winning more than one-third of the vote.

After outpacing the EM index by more than 950 bps in 2023, the MSCI India Index continued the trend in January, outperforming by more than 600 bps for the month. The Energy sector had the largest outsized performance relative to its weight in the index, as refiners continued to benefit from the Russian oil embargo, ongoing weakness from China’s refinery industry and supply chain disruption in the Red Sea.

We believe EM equities appear more attractive than developed international equities as relative valuations, upside earnings potential and the possibility of incremental fiscal and monetary stimulus are generally more supportive for the asset class (Figure 3).

Figure 3: Valuation and Growth Comparison
Valuations across global equity markets vary significantly

Date

NTM P/E (x)

2024 Consensus

EPS growth (YoY)

NTM

PEG

U.S.

20.4

11.4%

1.6

Developed ex U.S.

13.7

5.3%

1.4

Japan

15.0

9.7%

1.5

Europe

13.2

4.1%

1.3

  Euro Area

12.8

2.6%

1.2

  UK

11.1

2.2%

1.7

Emerging Markets

11.8

18.4%

0.8

  China

10.1

15.9%

0.5

As of 1/31/2024. Source: FactSet®.  FactSet® is a registered trademark of FactSet Research Systems Inc and its affiliates.

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TEXT VERSION OF CHARTS

Figure 1: Implied Probability of Interest Rate Cuts
Market pivots from expectations of imminent cuts (view image)

Date

March 2024 Rate Hike

May 2024 Rate Hike

June 2024 Rate Hike

1/2024

-35%

-97%

-112%

12/2023

-84%

-107%

-104%

11/2023

-48%

-60%

-73%

10/2023

-15%

-35%

-45%

9/2023

-16%

-33%

-44%

8/2023

-45%

-55%

-66%

7/2023

-47%

-54%

-69%

6/2023

-48%

-56%

-71%

Source: As of 1/31/2024. Source: Bloomberg L.P.

Figure 2: Leading Economic Indicators 
Diverging services inflation in the U.K. and Euro Area  (view image)

Date

UK Services Inflation

UK Services PMI

Euro Area Services PMI

12/2023

6.4

53.4

48.8

10/2023

6.6

49.5

47.8

7/2023

7.4

51.5

50.9

4/2023

6.9

55.9

56.2

1/2023

6

48.7

50.8

10/2022

6.3

48.8

48.6

7/2022

5.7

52.6

51.2

4/2022

4.7

58.9

57.7

1/2022

3.2

54.1

51.1

10/2021

3.2

59.1

54.6

7/2021

1.6

59.6

59.8

4/2021

1.6

61

50.5

1/2021

1.7

39.5

45.4

Source: As of 1/31/2024. Source: Bloomberg L.P.

Figure 3: Valuation and Growth Comparison
Valuations across global equity markets vary significantly (view image)

Date

NTM P/E (x)

2024 Consensus

EPS growth (YoY)

NTM

PEG

U.S.

20.4

11.4%

1.6

Developed ex U.S.

13.7

5.3%

1.4

Japan

15.0

9.7%

1.5

Europe

13.2

4.1%

1.3

  Euro Area

12.8

2.6%

1.2

  UK

11.1

2.2%

1.7

Emerging Markets

11.8

18.4%

0.8

  China

10.1

15.9%

0.5

Source: As of 1/31/2024. Source: FactSet®.  FactSet® is a registered trademark of FactSet Research Systems Inc and its affiliates.