Economic Data Watch and Market Outlook
Global stocks continued forward with the MSCI World advancing 99 basis points and the S&P 500 jumping 141 basis points for the week. Developed markets were up just two basis points for the week (MSCI EAFE) with the key driver, Japan’s Nikkei 225 advancing 1.14%. Had it not been for the Nikkei’s return, developed markets would have been negative. The Nikkei has even bested the S&P 500 on a year-to-date basis, although that’s just one month and two days.
The Fed left rates unchanged with speculation gathering steam that a cut was coming at the March meeting but that seemed unlikely after Friday’s announcement of 353,000 added jobs. This result exceeded all estimates with the average coming expected of 185,000 new jobs. The prior month was also revised up to 333,000 from 216,000. Private education and healthcare led the way with 112,000 new jobs. Just about every sector grew except for mining and logging which lost 6,000 jobs. Average hourly earnings also rose more than expected gaining 0.6% month-over-month versus an estimate of 0.3% The Labor Force Participation rate remained unchanged but the rate for men declined to 67.9% while the rate for women rose to 57.5%.
The House passed an expansion of the Child Tax credit which now heads to the Senate for additional approval but the date for a vote has not yet been scheduled. This credit is expected to contribute to family members staying in the workforce that may need to otherwise leave to address rising childcare costs.
Equities
As noted above the S&P 500 rose 1.41% for the week led by larger growth names. As the chart below from Factset points out the 10-year forward P/E is now above the 5-year average (green line) and the 10-year average (blue line).
The cap weighted S&P 500 result is what is often reported, and we’ve written about the Magificent Seven in past writings. These names Nvidia, Tesla, Meta Platforms, Apple, Amazon.com, Microsoft, and Alphabet have driven the benchmark and its valuation to new heights. The equal weighted S&P 500 is up just 0.2% year-to-date versus the cap weighted 4.06% return. The disparity is also evident when considering growth versus value names. The Russell 1000 Growth Index advanced 1.99% while the Russell 1000 Value rose 0.54%.
Consumer discretionary names advanced as Amazon released strong earnings on Thursday after the market close. The sector rose 3.72% for the week and is an example of how the Magnificent Seven dominate some portions of the benchmark. Amazon accounts for almost 21.7% of the sector while Tesla is at 13.6%. Technology, fell 89 basis points and was the laggard among the sectors. On the flip side, Apple, the largest weight at 21.5%, had a rough earnings report after iPhone sales fell 13% in Greater China, the worst in three years. Further, they guided lower for the March quarter. Microsoft currently has a 19.75% weight to the sector and Nvidia, a much smaller 4.20% weight.
Small cap names have not followed suit. The Russell 2000 fell 77 basis points for the week and is down 312 basis points on a year-to-date basis. Growth stocks are outperforming value stocks, but by falling less (Russell 2000 Growth, -1.69% versus Russell 2000 Value, -4.49%) on a year-to-date basis.
International stocks were mixed. As noted above, Japan, up 8.06 year to date, has been the key positive contributor to developed markets with European stocks down 1.00% year-to-date. Emerging market equities rose 32 basis points for the week but are down 3.43% year-to-date as indicated by the MSCI EM benchmark. Chinese stocks are the main contributor to that negative return with the Hang Seng falling almost 9% year-to-date.
Fixed Income
The US Bloomberg Aggregate Bond Index rose 1.49% for the week with short rates still higher than longer term rates suggesting a possible recession in the future. The Fed continues to maintain higher rates for longer and investor expectations for rate cuts are now priced in May. While mortgage rates are 7.19%, up slightly from previous weeks, housing continues to be an issue. Part of the Fed’s quandary related to rates is that the majority of current home owners locked in when rates were low and have no desire to sell. This has pushed demand for housing to new homes .
The Fed has also had trouble with corporate borrowing as higher rates have kept some borrowers out of the market. This seems to be the case in the leverage loan market and as a result some existing borrowers are asking current bondholders to reduce their rates. A recent Pitchbook LCD analysis revealed that 40% of leveraged loans are trading above par, up from 5% last October. The Wall Street Journal in a recent article points out that investors have generally approved the repricing and already have agreed to roughly $35 billion in rate reductions in January. As most leverage loans are floating rate, the reductions amount to spread reductions.
Hedge Funds as of February 1, 2024
Through January month-end, hedge funds (HFs) were able to post relatively strong returns vs. benchmark indices. The average global fund gained ~40 bps for the month vs. the MSCI AC World Index +60 bps, while the average Americas-based long/short (L/S) fund was able to end Jan +1.2% vs. the S&P ending +1.7%. When looking just since the start of the week, it was a good relative week for global and Americas-based hedge funds. The average global fund was able to post gains of just north of 10 bps vs. the MSCI ending +30 bps while Americas-based L/S funds ended +40 bps vs. the S&P +30 bps WTD. The stronger returns for Americas-based L/S funds this week could likely be explained by the fact that the more crowded longs in North America (NA) outperformed, with the group up ~80 bps this week (vs. the most crowded shorts up only ~10 bps).
In other regions, EU-based HFs posted gains of ~10 bps in January despite the Euro STOXX 600 Index ending up ~1.5%. Looking just at this week, the group posted gains of ~20 bps. Asia-based HFs were down ~1.2% on average, with China-focused L/S funds down even more at ~3.9%, though this comes as the MSCI China Index ended the month down 10.6%.
Both the end of January and beginning of February were relatively quiet in terms of HF trading activity, with both net and gross flows across most regions roughly flat for the week. In net terms, most regions skewed towards being sold in fairly small amounts with the exception of Europe, where HFs were small net buyers. In NA, flows across the board were muted with the only notable flow being consumer staples net buying and communications services net selling. Consistent with last week, HFs continued to sell mega-cap TMT through Wednesday, though flows to the group inverted on Thursday which ended up being a particularly sizable day of net buying. At the factor level, HFs were large net sellers of both size and quality with these two factors net bought in large amounts in the first two to three weeks of the year, but since mega-cap TMT began to be net sold, both factors have been net sold. Given the more muted activity in NA, both gross and net leverage across US equity L/S funds were relatively unchanged WoW.
Outside of NA, Europe was the only region to see any notable amounts of buying, with the recent activity driven by HFs adding to longs. Most sectors were net bought this week as almost all saw long additions, though the long adds were largest in consumer discretionary (led by textiles, apparel & luxury goods) and financials (split between capital markets and banks). Net exposure to European equities remains quite low vs. history, but levels have begun to inflect following the buying of EU vs. selling of NA in the first month of 2024.
Both Asia ex-Japan and Japan were sold in net terms this week with AxJ sold in slightly larger amounts than Japan. In AxJ, the selling was split across a number of countries, and while it is noteworthy that China flipped to being net sold on the back of the more challenging performance of the region this week, the magnitude of the selling itself wasn’t all that large. Looking to Japan, net and gross activity were roughly flat WTD. At a sector level there was a slight preference for cyclicals more than defensive sectors, but there was very little directionality to the overall net flow.
Private Equity
According to its “Views on Venture” report J.P. Morgan expects the venture market to face ongoing challenges in 2024 due to the lingering effects of past excesses. Whether it evolves into a prolonged period of adjustment or a more defined reset depends on the resilience of the economy and improvements in exit markets.
Looking ahead, most venture-backed startups are expected to require capital in 2024, with down rounds, M&A discussions, or closures becoming likely outcomes. The number of startups winding down due to bankruptcy or liquidation doubled in 2023 compared to 2022.
While there’s ample innovation and available capital, investors are cautious due to ongoing valuation uncertainties and high market exposure. For vintage years 2013 to 2019, over 50% of venture fund value relies on existing positions.
A phased reopening of IPO markets in 2024 could potentially lead to more normal IPO markets by 2025. However, geopolitical uncertainties and market volatility have impacted IPOs. The market has shown receptivity to companies with significant revenue scale, durable business models, and profitability. However, companies seeking to go public will likely need to endure a lengthy process, which can take up to 24 months.
Private capital dialogue remains elevated, with venture and growth investors putting capital to work, albeit at a slower pace. Crossovers have become more active in the market. The outlook for M&A is mixed due to valuation gaps, geopolitical concerns, and uncertainty. Deals are taking longer, involve more structure, and are relationship-driven. Additionally, the lending landscape for venture is evolving as startups seek capital. Companies with predictable revenue and operational track records are best poised to access venture debt.
Authors:
Jon Chesshire, Managing Director, Head of Research
Elisa Mailman, Managing Director, Head of Alternatives
Katie Fox, Managing Director
Sam Morris, Analyst
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.