Déjà Vu All Over Again
In the movie Groundhog Day, actor Bill Murray is forced to repeat the same wintry day in Gobblers Knob, PA waiting for a groundhog to forecast the future. January would not be a bad month to repeat as major stock indexes moved into positive territory. Yesterday, not so much. Software was a big laggard in trading yesterday, continuing a downward trend that began last October for the software sector. This trend was exacerbated yesterday due to Anthropic’s recent release of specialized AI tools for automating legal and other tasks. This weighed on a number of stocks where AI could automate many knowledge worker functions in legal or data gathering and analysis areas.
This is reminiscent of the DeepSeek scare about a year ago that negatively impacted many AI-related technology stocks in early 2025, or the April 2025 tariff-related selloff that took markets down early last year. Each year brings its own set of concerns, and the market typically has a drawdown sometime during the year. The average drawdown is actually about 14% in any given year, but is not fully indicative of full year returns. After three years in a row of strong stock market returns, investors are apprehensive. Meanwhile, the broader market has held up well given the selloff in software. This is due to a rotation into cyclical, consumer and value-oriented stocks. Five of eleven S&P 500 sectors were actually positive yesterday. For example, Pepsi# jumped 5% yesterday following its earnings report, while Walmart# surpassed a one trillion-dollar market capitalization for the first time, hitting new all-time highs.
The January Effect
January posted a 1.5% gain in the S&P 500 while the equal weighted index posted a 3.4% return. The S&P 500 is dominated by larger capitalization technology companies that have mostly lagged this year leading to a broadening out of investments. January returns can be a harbinger of full year returns with a high success rate, although this seasonal trend is not foolproof. There have been 12 major miscues since 1950. So far, it looks like the first half of 2026 will find a tailwind from tax legislation passed last year and potentially higher tax refunds, but the second half of the year remains an open question as tariff impacts still loom and monetary policy may change somewhat with a new Federal Reserve Governor.
The government shutdown has finally thawed out as the House passed funding legislation to end a partial government shutdown. The House voted 217 to 214 to fund a large portion of the government through the rest of the fiscal year. The Senate cleared the funding package last week. The legislation provides $1.2 trillion spread across five spending bills, including the Pentagon and Health and Human Services Department. At least that portion of fiscal shoveling has ended for now.
Manufacturing is Mixed
In the plus column, the Institute for Supply Management’s manufacturing index rose to 52.6 from 47.9, according to data released Monday. Readings greater than 50 indicate expansion, and the latest figure topped most estimates. The ISM Index had been contracting for nearly a year, so the demand-related gain in factory activity is welcome news. Sustained growth would help provide reassurance that manufacturing is on the mend after languishing for the past three years. The ISM report showed a nearly 10-point increase in new orders and a firm advance in the production index, both of which indicated the fastest growth in about four years. Order backlogs expanded for the first time since 2022 also, while export orders increased as well. The strength in demand reflected in part a decline in customer inventories. Lean customer stockpiles can provide a tailwind for factory orders and production in the future months. Adding to the data, a number of industrial-related companies have reported improvement in orders recently, including Parker Hannifin#. Aerospace industry demand continues to provide a lift to order books where companies have aerospace and defense exposure, such as for Raytheon#, which is scaling all-time highs.
As fourth quarter earnings season is underway, we are on track to mark the fifth straight quarter of double-digit earnings growth for the S&P 500. Blended Q4 earnings growth is now over 11.5%, up from 8.3% expected. In aggregate, earnings have been surprising to the upside by more than usual. Healthy consumer spending, at least on the higher end, was noted by Visa# and American Express#. Other favorable read-throughs from the travel and leisure space include airlines and cruise ship operators. Even Apple# talked up “staggering” iPhone demand and Levi’s highlighted strong holiday spending. Meanwhile, Chipotle is giving investors indigestion as traffic remains lackluster.
The complex forecasting models of the National Oceanic and Atmospheric Administration (NOAA) predict that the cold weather will continue for most of the month of February in the eastern United States, while the West stays warm. I think Punxsutawney Phil said basically the same thing with a little more fanfare. The risks from AI automation are real, although the tools should also enhance productivity in the long run. High valuations and optimistic earnings expectations do not leave much margin for error, however. Markets are indicated to open slightly higher this morning, so maybe we will avoid repeating Groundhog Day all over again.
School is still in session for singer Alice Cooper as he turns 78, while Natalie Imbruglia turns 51.
Christopher Crooks, CFA®, CFP® 610-260-2219