The bulls came roaring back in January as both the Dow Jones Industrial Average and S&P 500 logged their best January performances in three decades. The rally also constituted their largest monthly gains since October 2015, just two months after the Dow Jones experienced its first “Black Monday” of the new millennium with a 1,089-point drop at the open.
Investors are seeing a somewhat similar pattern of whipsawing now that January is officially in the bag. It was just over a month ago that investors were skittishly pushing the Volatility Index (VIX) to three-year highs as the Dow Jones dropped to a 15-month low. Though economic sentiment remains bullish at the moment, the fact that it’s largely grounded in a few words from Fed Chairman Jerome Powell’s mouth indicates sentiment could possibly turn sour again on a whim.
Here are the machinations behind the stock market’s stunning January performance – and what they may indicate about the month and year ahead…
The Numbers
The Dow Jones scored a monthly gain of 7.2%, marking the bellwether index’s best start to the year since January 1989 when it climbed 8%. More impressive was the S&P 500’s 7.9% leap, which came closest to its all-time January record of 13.2% back in 1987. As for the tech-heavy Nasdaq, the index scored a 9.7% gain for its best January since 2001.
Bank stocks largely paved the path for the rest of the market after ranking among the worst-performing sectors in December. The Dow Jones U.S. Bank Index, which strictly tracks the Dow Jones’s banking components, soared 11.6% since the Dec. 31 close. The best performers also happened to be Wall Street’s heaviest hitters: Bank of America Corp. (BAC), Goldman Sachs Group Inc. (GS), and Citigroup Inc. (C), which earned respective monthly returns of 16%, 19%, and 24%.
Tech giants also fueled the record-breaking rally, with long-suffering Facebook Inc. (FB) leaping more than 27% higher on the back of a stunning Q4 earnings report and a flurry of discount buying earlier in the month. Even the less glamorous firms ripped higher, including semiconductor producer Advanced Micro Devices Inc. (AMD), which climbed a massive 32%.
The Bigger Picture
Both the economy and stock market endured several tests in the final week of January, and it’s hard to oversell just how integral they were to the breakneck rally for equities.
Some of the world’s most valuable companies passed tests in the form of Q4 earnings reports, but the biggest economic test by far was the most recent Fed meeting. Investors who searched for market roundup stories after the closing bell on any given day this past week surely saw headlines regarding the Federal Open Market Committee (FOMC) meeting that took place on Tuesday and Wednesday. Last year, these two-day summits became anathema to investors fearing the easy-money days were coming to a swift end. These fears were realized following four rate increases in 2018, and they were largely reflected in December’s market rout.
However, Powell eased investors’ creeping anxieties by uttering one simple word in his post-meeting remarks: “patient.” He indicated that, given growing economic uncertainty and lowered fears of inflation, the committee would take a slower approach to raising the federal funds rate in keeping with how it sees the economy developing in the coming months.
His dovish statements were most responsible for the banking sector’s sharp and swift turnaround in January. That’s because lower rates fundamentally boost banking profits since it becomes cheaper for banks to borrow money in dovish rate environments. This lets them dish out more loans and grow their businesses with ease, ostensibly building revenue streams that are eventually returned to investors in the form of dividends and share-price gains.
But it’s important to remember the Federal Reserve has seven more meetings scheduled this year, and Powell’s post-meeting comments can drive markets in any direction despite the fact that the central bank’s economic views often change from month to month.
Wasif Latif, who heads the global multiasset investing division of USAA Asset Management, perfectly summarized the paradox in an interview with The Wall Street Journal, noting that “the flexibility that the Fed has telegraphed buys us a little more time to perhaps prolong this cycle.” He went on to say the banking rally is “more a reaction to interest-rate policy as opposed to economic data clearing the path for the market. That’s still up in the air.”
Libertarian opinions on the central bank notwithstanding, the Federal Reserve generally has the economy’s well being in mind when making decisions. Despite the truth that staving off rate hikes means the economy isn’t heating up as well as it should, a 49-year-low unemployment rate and rapidly rising wages prove otherwise. Even with the recent government shutdown possibly affecting the upcoming January jobs report, analysts expect a negligible effect on the overall numbers.
Looking Ahead
An analogy from Ritholtz Wealth Management financial advisor Josh Brown can help predict how the market and economy will perform in the coming months.
Brown asked NPR last year to think of the economy as a woman walking her dog, while the stock market is her hyperactive Jack Russell Terrier. The woman walks steadily ahead at a leisurely pace, while her Terrier naturally darts all over the place to sniff grass, chase some birds, and so on. Ultimately, though, the woman leads the dog in her general direction, despite the dog’s erratic behavior. They’re connected, but they don’t act the same.
That analogy perfectly encapsulates the economy and market’s relationship these past few months. Despite the economy’s consistent growth last year, the market frantically swung in every direction. But with the Fed announcing a new and more patient approach to rate hikes this year, the market looks poised to keep riding higher as investors embrace the central bank’s loose monetary policy. The economy and stock market are both strong right now, even though the latter acts erratically from time to time.
February is a historically bad month for stocks as they’ve lost an average 0.2% each year since 1998 and plunged 3.6% last February. However, the month tends to mimic January in terms of market performance. With a dovish Fed, as well as a rebound in banks and tech, February could end up being just as good, if not better, than January.