The first month of the New Year was a good one for the financial markets, thanks largely to the Federal Reserve. In December, the Fed slowed down its schedule for raising short-term interest rates and said they would likely slow down even more at their next meeting in February. Some positive economic news made investors optimistic the Fed would keep its word, and it all resulted in a positive month in the markets. Will the positivity continue—and if so for how long?

As you know, the Fed began raising short-term rates at a rapid pace in early 2022 to try to reign in rising inflation. That rapid pace kept downward pressure on the stock market all year and pushed long-term interest rates up to their highest levels in 13 years. The Fed only began slowing down after inflation had shown signs of slowing for five straight months, starting last July. In addition to raising short-term rates by only a half-percent in December (after having raised them by threequarters of a percent four times in a row) the Fed also strongly indicated they would probably enact an even smaller, one-quarter percent increase at their next meeting in February.

The Fed’s words were bolstered by some positive economic data released in January. Inflation, as measured by the Consumer Price Index, slowed yet again in December, falling by 0.1% for the month,* and economic growth measured a healthy 2.9% for the fourth quarter.** With all that, investors priced in a 100% chance that the Fed would stick to its plan for only a quarter percent rate hike in February, and they were right. As a result, the S&P 500 finished January up by 6.2% for the month.*** At the same time, long-term interest rates also ticked downward, with the rate on the 10-year government bond dropping from about 3.8% at the start of January to 3.5% by the end.****

Recession Still a Concern

The Fed’s more dovish tone and actions made investors happy for two reasons. The first is that falling interest rates have a positive effect on the value of all financial assets, just as rising rates have a negative effect. Remember, the market doesn’t value stocks and bonds based on where rates are now but on where it believes rates are heading. So, if investors think rates are going to rise, the market typically sinks, and if they think rates are going to stabilize or fall, the market rises.

The second reason investors were so optimistic in January is that, with the Fed slowing and nearing their target level for short-term rates — which is right around 5% — the chances are diminished that we’ll see a recession in 2023. Many economists are still forecasting a recession this year, and I agree there is probably still a 50/50 chance it could happen. But those odds would increase greatly if the Fed were still committed to raising rates at an aggressive pace rather than slowing down and nearing the finish line. What’s more, if a recession does occur, they now have plenty of ammunition to combat it by lowering short-term rates again — which they didn’t have a year ago when short-term rates were still near zero. That means even if we do get a recession, it isn’t likely to be a very long or painful one.

Your Portfolios

As noted, the S&P 500 finished January up by 6.2% for the month, and long-term interest rates notched downward a bit. As a result, both our Sound Income Strategies’ stock and bond portfolios finished the month up by a level commensurate with the stock market — just over 6% on average, depending on your individual holdings. That means if you saw your values down on paper by around 12-to-13% for 2022, you regained about half of those losses back in January.

Now, could we give some of those gains back again in the coming months? Of course. Although January was a good month and the markets are optimistic for now, the fact is the Fed hasn’t reached the finish line quite yet. Until they do, the markets are likely to remain in a pattern similar to what we saw throughout 2022: up one month and down the next. That’s just typical whenever the Fed is raising rates. And even after they have finished, the recession question could keep investors on edge for a while longer, in addition to other potential concerns like the looming showdown in Washington over the debt ceiling.

With all that said, I’m still optimistic — as I said last month — that calmer seas are on the horizon, and we will return to a more normal market cycle by the end of 2023. In the meantime, you can continue taking comfort in knowing you remain well-equipped to ride out the rough seas because you decided to shift your financial focus from total return to income. In other words, whether your statements are up or down from one month to the next doesn’t really matter because you know your income return is unaffected and the face value of your investment is protected regardless of any fluctuations in value on paper.

As always, I encourage you to call my office if you have any questions or concerns about your statements — or for any reason, such as a change in your goals or situation. Keep in mind that if your goals or needs ever do change, we should talk about it to help determine if your investment strategy should be adjusted in any way to align with the change!

*“Dow Closes 350 Points Higher, S&P Caps Best January in Four Years,” CNBC.com, Jan. 30, 2023

**Bureau of Labor Statistics

***“US GDP Rose 2.9% in the Fourth Quarter, More Than Expected,” CNBC.com, Jan. 26, 2023

****YCharts.com

Investment Advisory Services offered through Sound Income Strategies, LLC, an SEC Registered Investment Advisory Firm