January 2023 Monthly Market Review

Risk appetite remained elevated in January, with returns across many asset classes building from gains achieved in the fourth quarter of 2022.  Global equity markets rallied in January with roughly similar gains—in local currency terms—across the U.S. and developed non-U.S. markets.  Taking into consideration a weak U.S. dollar, the U.S. lagged.  Emerging markets (EM) equities rallied on continued optimism regarding China re-opening trade; China outperformed all other regions.  Interest rates at the front end of the U.S. yield curve moved higher with monetary policy changes, but intermediate and long-term maturities declined, causing the curve to flatten and the yield curve inversion to deepen.  Although commodities declined, the other segments of a real assets portfolio (real estate, natural resources equities, and TIPS) rallied.  Long/short equity managers—particularly those that shifted the composition of short portfolios away from high beta—were rewarded in January.

Capital market rallies fostered an easing of financial conditions that may present a challenge to the Federal Reserve’s inflation fight.  The Fed’s two-day policy meeting began on January 31, and as was widely expected the Federal Open Markets Committee (FOMC) downshifted from the 50 bps hike in December to a 25 bps hike.

During the press conference following the meeting, Chair Jerome Powell came off as being dovish, contrary to expectations of the opposite from many.  He dodged questions on future rate hikes and whether the forecasts contained in the December Summary of Economic Projections were still valid.

A disconnect remained between Fed guidance and market expectations regarding the path of interest rates at month-end.  The Fed has vowed to raise interest rates into restrictive territory (above 5%) and hold them there for “an extended period of time.”  Markets, however, do not believe the federal funds rate will pierce the 5% threshold and rather are predicting the start of an easing cycle in the second half of 2023.

Equity markets started 2023 with strong gains.  The S&P 500 Index returned 6.3% in January, and the broader Russell 3000 Index advanced 6.9%.  High beta stocks materially outperformed the broad market, with the Invesco S&P 500 High Beta ETF up 16.1%.  In a risk-on environment, small caps outpaced their large cap counterparts; the Russell 2000 Index gained 9.7% versus 6.7% for the Russell 1000 Index.

Growth stocks led value, with the Russell 3000 Growth Index gaining 8.4% versus 5.4% for the Russell 3000 Value Index.  Mega cap tech names posted sharp rebounds, with standouts such as Tesla (+40.6%), Amazon (+22.8%), and Meta Platforms (+23.8%).  Their strong performance pushed consumer discretionary (+15.2%) and communications services (+14.7%) to be the best-performing sectors for the month.  On the other hand, defensive areas such as utilities (-1.5%), healthcare (-0.8%), and consumer staples (-0.4%) did not participate in the rally.

Non-U.S. equities extended their year-end rally into 2023, with the MSCI EAFE and MSCI Emerging Markets returning 8.1% and 7.9% respectively.  Further weakness in the U.S. dollar (USD) remained a tailwind, adding well over 100 bps for U.S.-based investors.  In the developed world, continued improvement in macro conditions, particularly in continental Europe (+9.3%), also fueled market strength.  Economists broadly have reversed course on their outlook for the euro area.  The region is now expected to avoid recession due to lower than expected energy prices and a projected boost in global demand from China’s re-opening.

EM entered bull market territory on January 9th, advancing just over 20% from its intraday low on October 25,, 2022.  While the aforementioned improvements in the global macro-backdrop provided broad support, much of the rise was driven by sentiment toward China (+11.8% USD), which rallied following its swift reopening and expectations that Beijing will change course from a previously harsh regulatory environment in an effort to boost economic growth.

Most major emerging markets rebounded sharply, but China (+11.8%), Taiwan (+12.7%) and South Korea (+12.4%) were standout performers on the back of a notable recovery in the previously battered IT and consumption-related sectors.

India (-3.0%) was an outlier on the negative side.  Foreign capital flowed out of India and into China as investors become more constructive on the latter; this represented a reversal of a trend that spanned much of 2021 and 2022.  Additionally, a scandal at one of India’s most prominent industrial conglomerates, Adani Group, rattled markets.  The company’s 10 publicly listed stocks lost an estimated $102 billion in market cap; a $2.4 billion equity raise was canceled out when the share price fell below deal price range following a short-seller report accusing Adani Group of fraud and stock price manipulation.  While the group of stocks represent less than 1% of the MSCI EM Index combined, negative sentiment further pressured performance.  State-owned banks were hit particularly hard on uncertainty surrounding Adani-related loan exposure.

Fixed Income markets experienced a modest rally to start the year.  In this period, the rate of inflation slowed and the labor market showed relative stability.  Bond markets responded with positive performance across sectors for the month of January.  Longer-dated bonds outperformed in the month as yield shifted downward across the majority of the curve.  The very front of the curve remained elevated as short T-Bill yields rose modestly.

The corporate credit market saw an increase in bond issuance to start the year, which was met with growing demand and resulted in corporate spreads tightening 13 bps to 117 bps. High yield bond spreads tightened 49 bps and yields decreased by their largest one-month measure since July 2022. Securitized assets had a strong month as spreads tightened across MBS and ABS sectors.  Agency MBS led the group.

Most real assets categories were profitable during the month, including REITs (+9.9%), metals and mining (+12.5%), and midstream energy (+6.6%).  All outperformed broader equity markets.  The strong bounce in REITs returns followed a 24.2% category decline in 2022.  Increases came amidst falling rates, easing fears that a sharp downturn would mitigate demand for space and continued growth in net income across real estate sectors.   Historically, REITs have tended to overshoot to the upside and downside relative to private real estate, particularly during dislocations and market peaks.

Metals and mining stocks, a component of natural resources equities, rallied sharply as China’s relaxation of  its “zero COVID” policy and growing global demand from decarbonization efforts fostered optimism for a positive commodity cycle.  China is by far the largest consumer of copper, aluminum, zinc, and other industrial metals, and the reopening of the economy, many believe, will lead to a resurgence in these commodities.

Diversified commodities were slightly negative (-0.5%), driven by energy commodities (-9.7%). Natural gas prices (-23.8%) declined on the ongoing mild winter in the U.S. and Europe, while oil fell marginally (-0.5%) on uncertainty regarding when Chinese demand will ramp up.

Record earnings drove energy equities higher (+2.2%) despite weaker oil and natural gas prices and amidst record earnings reports.  Unlike commodities, which require increasing prices to be profitable, energy companies can produce attractive returns in a wide range of commodity prices.

Master limited partnerships, entities that  own and operate energy infrastructure assets, also posted strong returns during the month.  Energy infrastructure contracts typically contain inflation escalators, which—in addition to higher commodity volumes—provide a strong tailwind to cash flows in moderate to high inflationary environments.

Regarding the performance of long/short equity managers, January witnessed a sharp reversal in market leadership, as heavily shorted technology and consumer companies began the year with a significant bounce after an extended period of underperformance in 2022.  Last year was among the best for value-oriented short sellers since 2008 due in large part to the collapse in speculative pockets of the equity market.  Many long/short managers covered profitable shorts in the fourth quarter.  This set up a short covering relief rally for these beaten-down names.  The poster child for this dynamic was Carvana, whose stock price more than doubled in the first month of the year.  However, its shares were still down more than 90% for the year ended January 31, 2023.  Other profitable 2022 short positions, such as Peloton, Lyft, and Coinbase, followed a similar pattern and ripped higher in January.  Disciplined long/short managers that rotated their short books into lower beta names fared better than those that continued to hold short positions in speculative growth companies.

Indices referenced are unmanaged and cannot be invested in directly.  Index returns do not reflect any investment management fees or transaction expenses. This report is intended for informational purposes only; it does not constitute an offer, nor does it invite anyone to make an offer to buy or sell securities.  Information herein has been obtained from third-party sources that are believed to be reliable; however, the accuracy of the data is not guaranteed and may not have been independently verified. The content of this report is current as of the date indicated and is subject to change without notice.  It does not take into account the specific investment objectives, financial situations, or needs of individual or institutional investors.   All commentary contained within is the opinion of Prime Buchholz and intended solely for our clients. Unless otherwise noted, FactSet was the source for data used in this report. Some statements in this report that are not historical facts are forward-looking statements based on current expectations of future events and are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. Past performance is not an indication of future results.