January Outlook: New Year, Old Concerns—but Will Potential Falling Interest Rates Buoy All?

December delivered early gifts for investors, including a new all-time high for the Dow, retreating Treasury yields, and a Fed pivot on interest rates. But yet another debt ceiling countdown, new numbers on consumer borrowing, and the start of Q4 earnings season could make for a sobering start to the year.

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Key Takeaways

  • Another potential U.S. government shutdown, possible interest rate pause could define early ’24

  • Japanese monetary policy moves back into focus

  • As banks kick off Q4 earnings season, watch for signals on interest rates, consumer health, and the financial sector’s outlook

December delivered investors a stocking full of gifts, including a rally to new all-time highs for the Dow Jones Industrial Average® ($DJI), a steep drop in Treasury yields, and a Fed pivot on interest rates. But January threatens Wall Street with at least one lump of coal as renewed concerns about a possible U.S. government shutdown could quickly damage the holiday spirit.

While Congressional arm wrestling might not be what investors want to focus on coming back from the holidays, it’s one of many sticky wickets the market faces as 2024 kicks off. Other possible January stumbling blocks for the late-year rally include Q4 earnings season and another Federal Reserve meeting. Analysts have already been trimming estimates for Q4 company results because they saw signs of U.S. and global economic softness from some of the recent data. Many companies also issued negative guidance in the final quarter of 2023.

Another “dovish pause” by Fed on the way?

The Fed and its dovish pivot away from rate hikes in mid-December lit a fire under an already sizzling equities market and lifted Treasuries as well. The Federal Open Market Committee’s (FOMC) fresh projections indicated about three rate cuts in 2024, after 11 rate hikes between March 2022 and July 2023 raised borrowing costs to 22-year highs. Futures trading, however, galloped well past the FOMC in terms of optimism, baking in a possible six to seven rate cuts in 2024.

“Fed Chair Powell’s comments seemed to take any talk of ‘one more hike’ or ‘higher for longer’ out of the conversation,” said Kathy Jones, chief fixed income strategist at Schwab. “It’s just a matter of how many rate cuts and how soon.”

The market sees little or no chance of anything but a rate pause in January, by the way, keeping the Fed’s target range between 5.25% and 5.5%, where it’s been since late July.

Soon after the latest FOMC projections came out, a couple of Fed policymakers sounded a bit surprised at the market’s reaction, and one even suggested the Fed hadn’t discussed rate cuts at the meeting, which was news to investors.

It wouldn’t be surprising to hear more Fed policymakers add their thoughts in January because the new month also brings a handful of new voting members to the FOMC in a year that could see dissent among a generally united group at the Fed. The decision on rate cut timing is likely to spur debate within the FOMC and beyond. Going into January, Jones believes there’s a chance for around three rate cuts in 2024, starting in May.

In the wake of the Fed’s December 12–13 meeting, the benchmark 10-year Treasury note (TNX) yield sank below 4% for the first time since last summer, and the S&P 500® index (SPX) approached its all-time high near 4,800 set in early January 2022. By mid-December, the SPX was up more than 20% year to date after falling around 20% in 2022.

Department of overseas affairs

Between the Fed, earnings, and Washington quarrels, there’s plenty at home for investors to watch. Overseas developments also deserve a look, though, including chances that the Bank of Japan (BoJ) might start moving away from its negative interest rate policy and whatever’s next for the continued wars in Ukraine and Israel. Crude oil fell in December to nearly six-month lows below $70 per barrel on heavy U.S. production and signs of sinking Chinese demand, but more geopolitical tension could change things quickly.

Chinese and Japanese economic data also loomed large for U.S. markets in recent months. That’s expected to continue in January, with focus centered on the BoJ’s rate policy. In December, a Reuters poll found that about one-fifth of analysts expect the BoJ to begin unwinding its ultra-loose monetary policy as soon as January, and 80% expect the BoJ to end negative rates in 2024.

BoJ policy has potential ramifications for U.S. markets and the dollar. Higher rates in Japan, if they arrive, would conceivably strengthen the yen versus the dollar, a possible boost for large U.S. companies that sell products abroad. However, a higher yen could make products like Japanese cars more expensive for U.S. consumers.

U.S. Treasuries may also feel some heat in 2024 if the BoJ follows through with expected tighter rates. A return to positive yields for Japanese debt could potentially attract global investors back toward Japan’s bonds and away from U.S. Treasury notes.

D.C. countdown ticks again

Back in November, Congress punted its budget problems into 2024, where they await investors after the calendar page turns. Legislators were juggling Ukraine aid and border security as December wound down.

“Given the divisions in the two chambers, the most likely outcome is that Congress will have to continue working on the aid package when it returns to Washington in January,” said Michael Townsend, managing director, legislative and regulatory affairs at Schwab. “Of course, that’s the same time when lawmakers will be facing twin government funding deadlines in mid-January and early February.”

A prolonged shutdown could conceivably hurt the U.S. economy and consumer spending, both of which could possibly dent earnings. Even if there’s no shutdown, the sparring in D.C. can sometimes bring volatility to stock and Treasury markets, though this time there’s no threat of a U.S. debt default.

Turning to other government issues, relations between China and the United States appeared to improve in late 2023 after the two countries’ leaders met in San Francisco. December didn’t bring much news on the trading front, but investors might want to keep an eye out for any signs of new warmth leading to trade opportunities for U.S. semiconductor, agricultural, technology, and aviation firms.

Q4 earnings calendar looms

Q3 became the first earnings season in a year that S&P 500 companies grew their earnings per share (EPS) annually. Profits could be written in black ink overall in Q4 as well but worries lurk about the pace of earnings growth for both Q4 and 2024.

Negative Q4 guidance from S&P 500 firms is above the five- and 10-year averages, research firm FactSet noted, and analysts project Q4 EPS growth of just 2.4%. That’s followed by expectations for much stronger EPS growth of 11.5% in 2024. The recent forward price-to-earnings (P/E) ratio near 19 for the SPX is up from lows of around 17 last month and on the high side historically, meaning some of the forecasted double-digit 2024 earnings growth may already be priced into the market.

FactSet’s 2.4% expectation for Q4 EPS growth is down from its September 30 estimate of 8.1%. The downturn came as many companies guided for weaker results when they reported Q3 earnings, which was the first quarter in a year to see overall earnings rise instead of fall from a year earlier.

Earnings season begins in earnest on Friday, January 12, when several of the largest U.S. investment banks open their books. Investors have bid up financials sector shares since late October as yields fell.

For any banks that have bonds (specifically long-term Treasuries or mortgage-backed securities) on their balance sheets, the drop in yields means their values have risen a lot lately. “The surge in yields is what crushed financials earlier this year, so the drop in yields helps them,” said Collin Martin, a director of fixed income strategy at the Schwab Center for Financial Research.

All five industries in the financials group are expected to report year-over-year revenue growth in Q4, to lead all sectors at 7%, according to FactSet.

In 2023, info tech and communications services led all S&P 500 sectors in stock market progress with both up more than 50% year to date by late December. As earnings loom for mega-cap stocks in these sectors in late January, volatility could pick up on Wall Street. That’s because, by the holidays, mega caps still dominated the capitalization-weighted SPX despite signs of the rally broadening to other sectors. The mega caps are generally priced at multiples above their historic averages, meaning any sort of negative surprises has the potential for an outsized impact on the overall index. 

Investors got a sneak preview in December when shares of tech stocks Adobe (ADBE) and Oracle (ORCL) got punished after their earnings failed to light a fire under the bulls on Wall Street. The tech sector marches into 2024 with high expectations baked into their shares, for the most part.

“Once the economic path is clearer, we expect less bifurcation within the market—i.e., less violent swings in leadership—as the year unfolds,” said Kevin Gordon, senior investment strategist at Schwab. “That should bode well for groups that have failed to participate in the advance since the bear market low in October 2022.”

Hotter or cooler for data?

December’s economic numbers flashed competing signals in terms of the economy and rate policy. Job openings, wholesale prices, and the U.S. and European manufacturing sectors stayed chilly, but job growth, retail sales, and aspects of the Consumer Price Index (CPI) raised doubts about the pace of the economic slowdown and how quickly the Fed might be able to reduce rates in 2024.

Though the markets are closed Monday, January 1, the shortened week kicks off the month with a lengthy list of key data points. The most important are the Institute for Supply Management (ISM) December Manufacturing PMI® on January 3 and the December Nonfarm Payrolls report on January 5. The following week is arguably even more mission critical, featuring CPI and the Producer Price Index (PPI) for December. Then earnings season starts, and the Fed meets at the end of the month as everyone braces for a possible government shutdown.

In other words, rest and enjoy the holidays because January is jammed.

Happy trading,

Alex

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Key Takeaways

  • Another potential U.S. government shutdown, possible interest rate pause could define early ’24

  • Japanese monetary policy moves back into focus

  • As banks kick off Q4 earnings season, watch for signals on interest rates, consumer health, and the financial sector’s outlook

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