The month in summary:

All asset classes, including equities (U.S., Europe, China, EM), bonds (both USD and EUR), gold and cryptocurrencies posted strong gains at the start of the year.
Three key factors behind investors optimism were:

The inflation rate in the United States is cooling down. It dropped to 6.5% in December of 2022, falling for a 6th month in a row to the lowest level since October of 2021. Core PCE inflation, the Fed’s preferred measure, rose 4.4% from a year ago, which is the smallest annual increase since October 2021. At the start of February at the Fed meeting Powell even referenced to disinflation (a falling rate of inflation), which caused a market rally.

However, the data also showed that consumer spending, which drives more than two-thirds of all U.S. economic activity, is starting to wane. Adjusted for inflation, real consumer spending declined 0.3%. GDP data for 4Q also suggested that demand in the economy is slowly falling down. All in all it led to belief that the Fed would pull back from its hawkish monetary policy outlook.

China surprised the market with its abrupt quick end to zero-Covid policy at the start of the year. It led to expectations that the Chinese economy will be on the path to strong recovery in 2023, which would also boost demand for commodities and boost global trading. After a few years of lockdowns there is quite an amount of excess savings and pent-up consumer demand which may be a strong growth factor for the global economy in 2023.

Many suggested that Europe would eventually be in an energy crisis this winter. But relatively mild winter has defused any of these suggestions. At the end of January, gas storage in the EU was around 75%, and gas prices have fallen significantly. Investors' confidence in the Eurozone started picking up in November last year and continued its upward trend in January. More specifically, economic sentiment in the eurozone increased to 99.9 in January, the third consecutive increase. Service sector businesses were particularly upbeat. The eurozone composite purchasing manufacturers' index (PMI) also improved to 50.2, signaling a significant improvement in sentiment and that the region might avoid a winter recession.

Broadly speaking, US stock market demonstrated a massive risk-on rally, fueled by high hopes of soft-landing in the US, with investors carelessly ignoring any risks of further deterioration of corporate profits. Some even say that FOMO effect returned to the market in late January, with investors flocking to their all-time favorite technology stocks that disappointed in 2022 — like TSLA and NVDA, which alone explain a significant part of S&P500 growth for the month.

That surely provided support for all growth stocks. And especially steep rallies were seen in low-cap unprofitable tech names. After outperforming growth stocks by 24%-pts last year, value stocks underperformed by 5%-pts in January. Falling energy prices dampened momentum in the energy sector and the market rally weighed on the relative performance of defensive sectors like healthcare, utilities and consumer staples, which feature more heavily in value indices.

The unhealthy state of this risk-on momentum, and the scale of speculation activity, can be once again validated if we turn our gaze to the low-cap troubled names and meme-stocks where the short-squeeze stories and 100% daily fluctuations are emerging again. And a special mention here also should be given to the hype around chatGPT and the common public obsession of the artificial intelligence theme in the past month. A single mention by almost any company on some AI product development, even a very unspecified and immature, can trigger retail buying activity and popping stock prices.

The beginning of 4Q22 earnings season showed that US companies do not have a good case for corporate profits growth this year. Even the tech giants are slowing down and can hardly justify their massive multiples right now. Even the long-term obvious trends like semiconductors are breaking up this year, on the back of capex cuts around the world. Even the market darling, Apple, showed weak results for the quarter. Amazon and Alphabet followed with the same message. Intel results were a plain catastrophe. The only sectors staying their course now appears to be banks and healthcare — no one had high hopes for their results, and some of them thus have exceeded expectations. We suggest investors to focus their attention on these very sectors if they are brave enough to invest on a brink of recession.

All of the above give us a very troubled state of mind and reinforces our belief that investors should not jump in the US stock market just yet, or maintain a very conservative stance. Corporate profits are falling, corporations are firing a lot of people, the FED is still tightening, inflation is not yet tamed, markets are too optimistic. Retail investors should resist the FOMO and wait. This rally has a great probability to be another bear market rally, followed by a steep correction in the stock market.

Eurozone shares advanced further in January, as global investors reassess the region’s prospects relative to other geographies. Holding large investments in US stocks seems unprudent in the current environment, and other major options except Eurozone in the equity space are Emerging Markets and Japan. Whereas emerging markets correlate heavily with weakening commodities market and have additional geopolitical risks, Japan currently is in the midst of a long-awaited shift in economic trajectory which is difficult to bet on. The obvious choice now to reallocate capital in developed markets equity funds is thus the Eurozone.

Mild winter resulted in reduced energy demand, allaying fears of shortages, although energy costs remain the biggest component driving higher inflation. As natural gas prices are dropping to 2021 pre-war levels, confidence in more predictable economic environment increase and some corporations are now reviving their production plans and regular long-term planning activities.
On a relative basis, global investors are attracted into European stocks by their low multiples compared to the US, the idea that most damage from energy crisis is already done, and the prospects of strengthening euro. There is little chance to be caught in some overvalued IT-company propelled to the skies by retail investors hype, and a lot of room to find cheap banks and healthcare stocks. Another idea among the community is that the China recovery might boost eurozone economy in the coming months, providing additional consumer demand to the services and industrial sectors.
But, nonetheless, we think that even for the Eurozone, 2023 should be the year where bonds would shine the most, not stocks. As the risks are still plenty, and the recovery is yet to be seen. Stocks growth appears to be fueled only by hopes and expectations for now.

Importantly we should mention that recovery in the Eurozone was also supported by the recovery in euro currency. Recent trends (falling US inflation, China reopening) may lead to appreciation of EUR/USD to the 1.15 area in mid-2023.

Cooling inflation, the prospect of less restrictive monetary policy and a weakening economy boosted demand for bonds as well in January. There was a rally among all bond sub-classes, including US Treasuries, Investment Grade and High Yield bonds.

Most of the positive movement contributed to fall in US Treasury yields, particularly at the long end. The yield on the benchmark U.S.10-year Treasury declined to 3.4−3.5%, which is quite a long way from the October peak of 4.25%. The 30-year yield now sits at 3.5−3.6%. Yield on the shorter-term 2-year Treasuries faded over the month to 4.1−4.2%. As we can see, part of the curve remains inverted, which is one of the main signals for incoming recession.

Credit spreads for both investment-grade and high-yield bonds have continued tightening in recent months despite the recession fears. It resulted in strong performance both in Investment grade bonds and in high yield. As it normally happens, when there is an increase in demand for risk, high-yield bonds are one of the main beneficiaries. In January in particular, the best performance in bond sub-sectors was in distressed markets (Chinese developers, bonds of Argentina, Lebanon).

Eurozone inflation for January edged down to 8.5%, easing from 9.2% in December. It was the third monthly decline since the inflation rate hit 10.6 percent in October 2022. As a result Germany’s 10-year yield dropped from 2.32% to 2.08%. The US dollar continued to slow down in January, as all G-10 currencies showed gains against the greenback. All this resulted in strong demand for eurobonds in EUR currency — both in investment grade and high yield space.

Gold prices were on the third straight monthly gain, recording additional 5.7% growth in January 2023. This time the main reasons behind gains in gold prices were the weaker dollar and expectations around slower rate hikes from the U.S. Federal Reserve. As a result of these expectations shift, 10-year TIPS yields in January decreased 30 bps from 1,58% to 1,28%. Lower rates tend to be beneficial for bullion, decreasing the opportunity cost of holding the non-yielding asset. We still believe that gold prices would benefit significantly from change in Fed policy in the middle of 2023. But at the moment it looks like the market is 'getting ahead of itself' and we will likely see some near-term correction in prices.