The first quarter of 2023 brought surprises and volatility in both the bond and equity markets. Stocks dealt with the bank failures in both the U.S. and Switzerland well. As concerns in the banking sector eased and inflation numbers continued trending downward, both the S&P 500 and Nasdaq posted gains for March and the first quarter. So far, no recession.
As of March 31st, the S&P 500 was up 7.0% for the year while the Nasdaq shot up 16.8%. The Dow Jones and Russell 2000 trailed with gains of 0.4% and 2.3%, respectively.
The Fed raised only a quarter of a point. The bond market was very volatile as the bank failures played out. The 10-year ended at 3.5%; the 2-year at 4.9%, all data according to Bloomberg. WTI oil ended at $75.46 but then OPEC announced production cuts this week.
Market breadth was narrow. According to Morgan Stanley, 95% of the S&P 500’s returns came from just 10 companies, all tech giants. Some market mavens speculate that these concentrated gains may not continue; either the market broadens or the titans pull back.
Other forecasters posit that the Fed will loosen monetary policy sooner than expected. As a result, we have seen capital piling back into the tech behemoths. Some headlines have even called the big technology companies “safe havens” as they don’t need credit to grow while cyclicals and some other industries do. As often happens, last year’s winners give back much of their gains and the battered clawed back to higher levels.
Numerous commentators and long experienced market participants have observed that the current period is the most or among the most difficult to forecast, hence the volatility.
The yield curve remains inverted as bond investors believe the Fed will need to cut rates due to a future economic slowdown. We continue to take advantage by investing in Treasury Bills providing risk-free rates over 4%.
In the 13th month of the Fed’s rate hike cycle, the rapid rise in rates finally broke something: 3 regional banks who failed to manage duration risk and the long-troubled Credit Suisse. In the U.S., the Fed and the Treasury essentially provided a government backstop to all deposits, even those hugely above the $250,000 limit, as well as a temporary special lending program for banks. This is monumental intervention by the Fed and Department of the Treasury to prevent “contagion”. Thus far, it has cooled panic. As always, previous government policies are declared blameless, and only more regulation can prevent future problems. Markets are properly skeptical.
Analysts believe the Fed will hike another 25 bps at their next meeting in early May. Investors are sensing the end of monetary tightening is near and the Fed will soon back off the restrictive policies.
Historically, the end of a tightening cycle has been a positive for stocks. Already the conversation on Wall Street is shifting to “when” and “how fast” will the Fed begin cutting rates. We believe this is probably premature and may add risk or even be a “bear trap”.
Q1 earnings season will give us another glimpse into the economy. For the S&P 500, the estimated Q1 2023 earnings decline is -6.6%, which would mark the largest decline since Q2 2020, according to FactSet. As always, how the market reacts to earnings is relative to expectations. We expect continued volatility in Q2.
Doug Coppola - Executive Director & Investment Committee Chairman
Steve Lindgren - Chief Investment Officer & Partner
Bob LeBeau - Research Director & Investment Committee Executive