Macro

Blockbuster US Jobs Report gives a surprisingly strong start to 2024, showing that the labour market remains remarkably resilient. The payroll report nearly doubled economists’ forecast (185k), adding 353k jobs in January, and significantly revised December’s number from 216k to 333k. Hourly earnings jumped 0.6% in January (faster than December and November gains of 0.4%) for a 4.5% TTM. Although a weaker labour market is not a prerequisite for rate cuts, adopting a less restrictive monetary stance with such a vital job report will be difficult for the FED.

Growth in the US is very strong relative to recent history and other developed markets, which have stagnated. Economists find it difficult to believe that after a 500 bps rate increase, the economy is in full employment with a shortage of workers in the services sector, and the equity market is at all-time highs. Yet, despite the strong economic growth, the US is running a massive 6-7% GDP budget deficit, which post-second World War is a record rate during such a strong economic boom.

The magnitude of debt put by society is dangerous and will have unintended consequences in the long run. One of them is growing debt servicing costs, which can crowd out spending on productivity-increasing activities. While the international buyers of US debt, such as China and Japan, have pulled back, the Treasury needs to rely on more price-sensitive private buyers. This upward pressure on the cost of debt creates a more upwardly sloping yield curve. Given the increased treasury supply and average borrowing cost, it also pressures the FED to cut rates to decrease the average US borrowing cost.

The only two solutions are raising taxes and cutting spending, both economically contractionary.

Rates

Robust economic data will impact FED’s decision on the timing and extent of the rate cuts. The market did get carried away with pricing in the number and extent of the rate cuts, and then after the payroll number dramatically repriced yields. 2Y yield by 1 pm on Friday, shooting up about 20 bps.

Yields have the risk to the downside as the stance towards the cuts was too optimistic. We also see a more significant risk due to the volatility moving more towards the front of the curve. Further repricing is likely, which makes duration very risky.

Credit

We had the business January ever for the IG Credit with close to $200b of supply. Increased issuance is a response to lower yields and tight spreads close to the bottom of the historical range. Companies are trying to take advantage of the tighter spreads and declining rates and answer to very high investor demand for credit issuance. Large companies tend to have fixed-rate debt, making them less sensitive to interest rates; however, increased average borrowing costs put pressure on companies with weaker balance sheets. 25% of the high-yield market is coming due over the next three years, but the upcoming maturity wall is not only a threat but also an opportunity for credit investors.

Yields and credit spreads have drastically repriced this week due to concerns around the New York Community Bank and the credit quality related to the commercial real estate sector. New York Community Bank (NYCB) lost nearly half its market cap within a week (from $10.44 on Monday to $6.04 on Friday close) as it suffered higher-than-expected losses from real estate loans. Despite drivers of NYCB issues also affecting other banks, as of now, this looks more like a stand-alone event rather than a systemic problem.

Based on current spreads, investors are getting approximately 100bps compensation for IG credit risk compared to Treasuries. The majority of the IG credit premium is compensation for liquidity risk.

Equity

2024 so far proved that the equity market is getting stronger. The S&P 500 is approaching a level of 5,000 points, a significant technical level. With a solid 3-month rally starting from the end of October, the equity market will likely feel some resistance around that mark.

Earnings revision is one of the key drivers of stock performance in this market. Technology and communication services are the only two sectors with a positive earnings revision, and those are forming market leadership. With 20.4x forward earnings, S&P is relatively expensive, but there is still room for growth and momentum to continue. Current exposure of 67% is below the 71% peak in 2019 and 2021. Valuation looks more attractive outside of the Magnificent 7. Investors are paying a modest 15x 2025 earings for S&P 493 stocks.

Small caps are trading at 44% of the large caps’ Price to book; the last time this happened was in 1999, the beginning of a 12-year period of small-cap outperformance. Broadening the stock market requires equity inflows. The last large inflows for December created a spectacular move in the Russell 2000.

From a positioning perspective, investors are generally underinvested in equities. Over $6t is sitting in money market funds, while the S&P 500 generated more returns in a few weeks of 2024 than money market funds in a year.