The S&P 500 (a benchmark for U.S.-listed stocks) is up 5% year-to-date. That’s pretty impressive given that we’re just two months into the year.
But here’s the curious part. Last month, 82% of the companies in the S&P 500 reported their Q4 2022 earnings. These were down 4.7%.
Now, when corporate profits go down it’s generally not a catalyst for stocks to surge.
But what’s even more puzzling is that the riskier and smaller stocks of less established (and often unprofitable) companies have done even better. Far better, in fact.
The tech-heavy Nasdaq was up roughly 18% at one point last month. The index remains up 10% at writing.
The Russell 2000, the world’s best-known benchmark for small-cap U.S. stocks, is up 11%.
Keep in mind that many companies listed on these two indices aren’t even profitable, making their stocks much more speculative bets.
In other words, risky assets are staging a big comeback, even in the face of continued rate hikes from the Federal Reserve.
That’s a strange situation… especially when fears that the economy is entering a recession in 2023 remain elevated.
You just don’t go all-out in buying stocks at a time like that… let alone buying the riskiest ones.
So, today I want to talk about what’s happening here… and what it means for you as an investor.
The January Effect
The market had a huge rally in January. And while there were a number of factors driving this, much of it was, well… seasonal.
This is something you might have heard of… it’s called the “January effect.”
It’s a so-called market anomaly where stock prices go up in the first month of the year. In fact, historically, stock market prices have risen more in January than in any other month.
You can see this in the next chart, which spans 70 years’ worth of data.
That’s in part because people sell off their assets in December, so they can close the year claiming a capital loss to reduce taxes.
That’s exactly what happened in January of 2023.
If you look at the chart above, you’ll see how stocks as a group were on an upward trajectory throughout the month, peaking as the month ended.
But that still doesn’t explain why riskier stock indices have done better than the S&P 500…
The Market’s Bet
It’s because the market believes inflation is going away soon. And if you look at the next chart of the Consumer Price Index (CPI), it certainly seems that way.
(The CPI measures changes in the price level of a basket of consumer goods and services.)
As a reminder, the Fed uses metrics like the CPI to measure inflation and determine economic policy, regardless of whether it’s an accurate measure of the real inflation people experience every day.
So with those metrics like the CPI on a downtrend, the Fed is unlikely to continue increasing interest rates for too long.
And recession fears are lending more weight to these expectations.
For one, as I told you in my essay on the latest jobs report yesterday, the labor market isn’t really as robust as it appears to be.
And, of course, rising layoffs play a big part in this.
Recently, Amazon, Google, Microsoft, and Facebook have all hit workers with big layoffs… In fact, Big Tech has cut more than 330,000 jobs since January last year.
A weakening labor market and slowing economy mean less wiggle room for the Fed to continue raising rates aggressively. After all, the central bank doesn’t want to have a full-blown economic crisis on its hands.
What This Means for Your Money
There is an adage: “Don’t fight the Fed.”
Now, I don’t think investors are wrong about the Fed’s shift to a dovish policy after remaining hawkish throughout 2022… I myself have been talking about the three stages of the Federal Reserve’s pivot to neutral monetary policy since August.
That said, there’s still a lot of uncertainty in the markets in terms of what the Fed will do at its March 21 meeting. So, my advice for anyone looking to venture into the stock market right now is to tread carefully.
That does not mean you should keep all your investments in cash.
Instead, I recommend investing a fixed amount of money on a regular basis, typically monthly or bi-weekly. This is what we call “legging in” or “dollar-cost averaging.”
You can also buy more when the stock market is cheap and less when it’s expensive.
Ultimately, it comes down to another useful mantra: “Time in the markets is more important than timing the markets.”
That’s because the longer you stay invested in the market, the more you increase the odds of making money from it. That’s regardless of what the Fed does in the short term.
One way to take advantage of that is with the Vanguard S&P 500 ETF (VOO).
This exchange-traded fund (ETF) tracks the S&P 500 Index. It allows investors to gain broad exposure to the U.S. stock market.
It’s a straightforward investment you can access in a regular brokerage account. The fund doesn’t try to outperform the index. Instead, it aims to replicate its performance as closely as possible.
Editor, Inside Wall Street with Nomi Prins