Economic Data Watch and Market Outlook
Positive returns in equity markets erased the losses from the beginning of the year in broad market indices with the S&P 500 rising 1.87% for the week bringing the year-to-date return to 34 basis points. The MSCI World rose 1.55% and is flat year-to-date. Digging further into the return, growth stocks continue to be the driver of the broad market indices with the Russell 1000 Growth up 84 basis points for the year while the Russell 1000 Value has declined 62 basis points with commodity and interest rate sensitive companies also declining.
Jobless claims were slightly lower that forecasted, 1,834K versus the 1,871K estimate. Core CPI year-over-year was a bit hotter than expected at 3.9% versus 3.8%. Core PPI year-year-over year came in lower than expected 1.8% versus 1.9%. The goods component within PPI declined for the third consecutive month and services were flat.
As noted in last week’s piece, many cargo ships are choosing to sail around the Cape of Good Hope instead of moving through the Red Sea in order to avoid being overtaken by Houthi rebels out of Yemen. Passage around the African coast can take 20 days or more impacting global supply chains. The United States and the United Kingdom launched airstrikes against the Houthis in hopes of establishing safer passage to commercial vessels. As a result of the re-routing, shipping rates have surged.
US Consumer credit spiked as the November reading was published January 8th. The forecast was for a $9 billion increase with $23.75 billion reported. This number can be volatile and revisions will likely be accounted for during next month’s report but the result provides insight into the impact inflation had in 2023. The consumer may need to overcome hurdles as we try to determine if the economy will indeed have the expected soft landing widely discussed in the press.
The upcoming week is shortened by the observance of Martin Luther King Day, but we will learn more about consumer spending as retail sales data is released on Wednesday, Philadelphia Fed Manufacturing data and jobless claims on Thursday and existing home sales on Friday. On the political front, Iowa Caucuses are taking place and negotiations continue regarding the government shutdown on Friday.
Equities
Large cap technology names helped rescue some early January losses this week pushing major indices near new highs. New AI powered chips from Nvidia and Advanced Micro Devices led the rebound Monday which caused the Nasdaq to gain 2.20% Monday. There was a broad-based rally ahead of key inflation data and earnings reports towards the end of the week. The comments made by numerous Fed officials that the market was ahead of itself on rate cuts caused trading volatility midweek leaving indices mixed. A higher-than-expected CPI report and a drop on jobless claims on Thursday had the markets little changed, and Friday’s PPI report balanced out the inflation outlook pushing yields lower. The week brought an unofficial start to earning season as four of the largest US banks reported fourth quarter results on Friday with all four banks reporting help from high interest rates. JP Morgan Chase, Bank of America, and Wells Fargo exceeded analyst’s expectations as their customers had kept up spending. Citigroup reported a net loss of $1.8 billion for the quarter compared to a gain of $2.5 billion in Q4 2022. The bank noted that one-time expenses from efforts to pull back from countries such as Russia and Argentina were costly. It also stated that they plan to cut 10% of their workforce as a part of its restructuring effort. JP Morgan earned $9.3 billion in Q4 and revenue for the quarter was $38.6 billion. Bank of America’s profit shrank last quarter as it paid a $2.1 billion special assessment to the government fund that pays for the cost of bank failures. The bank recorded a $3.1 billion profit for the quarter and revenue of $22 billion. Brian Moynihan, Chief Executive, said it was a solid quarter with good loan demand and growth in customer deposits. Wells Fargo earned $3.4 billion and reported $20.4 billion of revenue during the quarter. Michael Santomassimo, Chief Financial Officer, said reductions in the workforce would be broad based across the bank and attributes the future cuts to efficiency of work done across the bank.
For the week, the Dow Jones Industrial Average gained 0.35%, the S&P 500 gained 1.87%, and the Nasdaq gained 3.09%. The small cap Russell 2000 Index was flat for the week and lagged large caps as the Russell 1000 Index gained 1.82%. From a style standpoint, growth outperformed value across market caps, which has been the trend year-to-date. Market sectors were mixed but strength in large tech helped the technology sector top the leader board for the week followed by communication services, consumer staples, and healthcare while energy, utilities, and materials saw weakness for the period. Energy was impacted negatively by the pullback in oil prices early in the week.
Globally, equities were mostly positive as the MSCI World gained 1.55% and developed markets outperformed emerging markets as the MSCI EAFE Index, which tracks 21 developed markets excluding the US and Canada, gained 0.87% while the MSCI Emerging Markets Index lost (-0.57%). In Europe, the Euro STOXX 600 Index ended the week unchanged as investors assessed the prospect of higher for longer interest rates. Germany’s DAX gained 0.66%, UK’s FTSE 100 Index declined (-0.84%), Frances CAC 40 rose 0.60%, and Italy’s MIB was slightly higher during the week. In Asia, Japanese equities saw strength during the week as the Nikkei 225 gained 6.59% and the broader TOPIX rose 3.40%. The continuation of stimulative monetary policy and weakness in the yen helped indices rally to their highest level in almost 34 years. Chinese equities recorded losses as data related to China’s deflationary cycle persisted into December raising expectations of increased government intervention for 2024. The Shanghai Composite fell (-1.61%) and the Blue-Chip CSI 300 lost (-1.35%). In Hong Kong, the Hang Seng Index fell (-1.76%).
Fixed Income
2-year Treasury yields hit their lowest levels since May 2023 on Friday after a lower-than-expected PPI report fortified bets on Fed cuts this year. Expectations for the Fed’s next move have been volatile over the last month, with expectations of the first cut coming in March swinging between 50% and 80%. Meanwhile, Thursdays CPI report came in hotter than expected. Ultimately, traders are expecting the first cut to come in May, and the market is beginning to temper its expectations for more hawkish moves by the Fed this year. Treasury yields finished the week lower with the 2-year Treasury yield falling 26 bps to 4.14%, the 10-year Treasury yield falling 9 bps to 3.96%, and the 30-year Treasury yield falling 1 bp to 4.20%. Furthermore, the Bloomberg US Aggregate Bond Index climbed 0.47% through Thursday, the Bloomberg US MBS Index rose 0.66%, and the Bloomberg US Corporate High Yield Index rose 0.75%.
On Friday some of the world’s biggest banks reported earnings and surprised analysts by forecasting a slide of Net Interest Income (NII) in 2024. As smaller banks have suffered in the wake of the Fed’s rate hike cycle, top banks fared better in 2023. Throughout last year JPMorgan, Bank of America, Citigroup, and Wells Fargo pulled in a combined $253B in NII which is the difference between earnings on assets and debt payments. This trend is expected to change as banks start to consider rate cuts more heavily. Wells Fargo lead the way, predicting a 9% drop in NII in 2024, while Citigroup forecasted a more modest decline. JPMorgan closed out its most profitable year in US banking history and had a positive income outlook going forward.
Municipal bonds are gaining market share in separately managed accounts, which allow investors to build customized portfolios with the help of professionals. Bloomberg estimates that there is between $600M to $1T of muni bonds held in these accounts. Citigroup has estimated that this market has grown over 40% in the last 10 years to about $750B, while mutual funds have been shedding municipal bond assets since 2021 from approximately $1T to $727B in Q3 2023. This move comes as municipal bonds are yielding multi-year highs.
Hedge Funds as of Thursday, January 11th
Hedge funds (HFs) have had a relatively stronger start to the year with the average global fund down only -4 bps (vs. MSCI World -60 bps), while the average US long/short (L/S) equity fund is up 20 bps (vs. S&P 500 +26 bps). The average EU-based HF has experienced ~20% of the downside in the Euro STOXX 600 as they are down 22 bps so far through January. However, performance has been most challenging for the Asia-based HF group as they are down 74 bps MTD (vs. MSCI Asia -1.7%).
HFs were net buyers of global equities this week, though when splitting up the flows by region, all regions except for North America (NA) and China were net bought. Within the US, as mega-cap TMT names outperformed the S&P and the momentum of rally in small-caps slowed, there was a clear tilt in the flows at the factor level towards buying size and quality. Tech was the only sector to be materially net bought as HFs continued to add longs within software and semiconductors. To note, the buying in the sector has broadened out beyond the “Magnificent 7” to include additional companies that fit the large/mega-cap tech names. HFs were also buyers of healthcare, the largest in nearly five months, and according to Goldman Sachs, it is the largest net overweight sector vs. the S&P 500 in their prime book. Meanwhile, HFs were net sellers of ETFs as they added to index-level hedges, notably this comes after HFs trimmed a decent portion of long exposure to the group over the prior week. HFs were also net sellers of financials (the largest in 16 weeks), as earnings season kicks off, as well as materials via containers & packaging.
Globally, Japan led the net buying as most sectors were net bought (except for materials, energy and utilities). Industrials and healthcare led the buying as HFs both added to longs and covered shorts, followed by tech where HFs added to gross exposure with a buy skew. HFs were also net buyers of Europe as they added to longs in greater amounts than they added shorts, with the buying led by long adds in healthcare across biotech and pharma, as well as a mix of long adds and short covers in consumer staples (personal care products and household products, respectively). Asia ex-Japan also tilted net bought driven largely by tech in both South Korea and Taiwan, as well as long additions in Australian consumer discretionary. However, a portion of what was bought was offset by selling in China and India. At the sector level, the selling in China was relatively spread across consumer-related sectors and tech, while India flows were driven by selling in financials and communications services.
Private Equity
In 2023, healthcare-focused private equity (PE) managers scaled back their activity levels compared to previous years, and it is anticipated that this conservative trend will persist into 2024. The total value of healthcare-related PE deals plunged by 60.4% from its peak in 2021 to the lowest point seen since 2016, as reported by PitchBook’s 2023 Annual US PE Breakdown. Furthermore, healthcare’s proportion of the total global PE deal count receded from its 2020 high of 13.7% to 10.8% by the close of 2023.
PitchBook analysts forecast a continued descent in healthcare’s slice of the global PE and VC deal count for 2024, a development influenced by soaring interest rates which elevate the cost of leveraging and consequently deter the deal types preferred by these investors.
PE healthcare managers are expected to keep channeling capital into their existing portfolio entities and into acquisitions in the lower-middle-market segment, yet the archetype of PE healthcare investment is evolving. The occurrence of physician practice management roll-ups by PE managers is on the decline. The Federal Reserve’s hikes in interest rates have made it increasingly difficult for PE firms to load up on debt to fuel the inorganic growth of their holdings.
Add-ons, a critical strategy for PE healthcare players that typically necessitates debt financing, have become progressively less viable. This departure from add-on strategies is also linked to the inflation of labor costs. The healthcare industry, already grappling with labor scarcities amid the COVID-19 pandemic, faces heightened wage expenses.
Despite challenges, the industry continues to spot other sources of opportunity. PitchBook analysts project that the industry will lean into pharmatech investments, exploiting the pharmaceutical sector’s intensifying focus on biologics, including treatments based on antibodies, proteins, and the arena of obesity treatments.
Authors:
Jon Chesshire, Managing Director, Head of Research
Elisa Mailman, Managing Director, Head of Alternatives
Katie Fox, Managing Director
Michael McNamara, Analyst
Sam Morris, Analyst
Josh Friedberg, Fall Associate
Data Source: Apollo, Barron’s, Bloomberg, BBC, Charles Schwab, CNBC, the Daily Shot HFR (returns have a two-day lag), Goldman Sachs, Jim Bianco Research, J.P. Morgan, Market Watch, Morningstar, Morgan Stanley. Pitchbook, Standard & Poor’s and the Wall Street Journal.