2023 | 1st Quarter
Stocks finished strongly in March with the S&P 500 up 7.5% for the quarter, despite some “event” induced turmoil. As the markets closed with positive performance in January, you could be forgiven for believing that 2022’s downturn was in the rearview mirror. February’s inflation-driven volatility was a stark reminder that perhaps the earlier optimism was short-lived and in March, fears of weakness in the banking system shook markets.
Markets sold off in February and early March stemming from Federal Reserve (Fed) Chair Powell’s strong stance on impending interest rate increases, punctuated by rampant rumors that Silicon Valley Bank was in trouble. Those rumors morphed into its insolvency and closure by the California Department of Financial Protection and Innovation on March 12th . Investors were inundated with various opinions referencing another ‘Lehman moment’, which triggered the 2008-09 financial crisis. Although not a replica of September 2008, other banks followed suit: New York State regulators closed crypto-friendly Signature Bank due to “a systemic risk exception,” and crypto-focused Silvergate. Troubled Credit Suisse was purchased by UBS, and Republic Bank is being rescued by a financing package from more stable banks.
While the troubles at the aforementioned banks were mainly due to their individual business practices and not a system-wide crisis, investors exited the stock market and headed for the safety of cash and short-term Treasurys as banks’ share prices plummeted, with smaller community banks hit hardest. Yet every disaster has a bright spot, and the banking crisis forced the Fed to hike a mere 25 basis points (bps) at its March 21-22 FOMC meeting.
A recap of market indicators: The Dow Jones Industrial Average (DJIA) closed 2022 at 33,147, the S&P 500 Index was 3,840, and the yield on the bellwether 10-year Treasury Bond was 3.88%. On March 31st, 2023, the DJIA closed at 33,273, the S&P climbed to 4,109, and the yield on the 10-year Treasury Bond fell to 3.49%
We’ll examine three themes in this quarter’s Market Commentary: Fed policy, the inflation outlook, and the likelihood of a recession.
Fed policy – The Fed is committed to combatting inflation—in our view, it’s been behind the curve for some time. Though its target is 2% for the Consumer Price Index (CPI), it still has work to do: CPI is up 6% from last year. However, it is making progress: CPI rose 0.1% in December, ticked up 0.5% in January and then declined to 0.4% in February. We forecast a gradual slowing of rate hikes, and possibly pausing by Q4. But another 25-basis point hike may be on the table for May.
Inflation outlook – Spending patterns are best measured by the Personal Consumption Expenditures Price Index (PCE). The index was up 0.1% in December (which was revised upward in February to 0.2%), catapulted to 0.6% in January, and increased by 0.3% in February.
Overall inflation has fallen for seven consecutive months, but February’s figures show food was up 0.5%, and January’s year-over-year figure showed an increase of 11.3% from a year earlier. Prices are rising faster from a higher base. Although fuel and energy costs have declined (oil hit $66/barrel on March 17th – the last time it was that low was November 26th, 2021 – before rising again), they are still high. Consumer prices are expected to increase by 6.3% over the next 12 months, a slight improvement from January’s 6.7% expectation.
Recession viewpoint – pro and con Opinions about the economy heading into a recession vary. The technical definition of a recession is two successive quarters of negative growth and while this has not happened yet, there are signs of slowing.
The yes case:
• The banking fiasco means banks will be more cautious in lending to both businesses and consumers, which will dampen spending and curtail growth.
• Tight money conditions tend to accompany economic slowdowns. Consumers are pulling back: Retail sales declined 0.4% in February after rising 3.2% in January. Many will be forced to cut back spending as they incur higher interest rates on credit cards and car loans.
• Employment, though strong, is showing some stress. Initial claims ticked up in February and March, and the ADP National Employment Report reported 242,000 new jobs were created in February. But private payrolls declined markedly.
• Although we typically do not hold gold, as it doesn’t pay a dividend and incurs a cost to store it, it tends to be a recession indicator, and has been on the rise in March, reaching $2,000 per ounce by late March.
• Recessions typically occur after the stock market bottoms. If we have indeed reached a bottom, a recession may be in the offing, though whether it will be a ‘soft landing’ is up for debate. However, a massive amount of cash is sitting in money market and savings accounts, and when rates drop, as some predict will occur later this year, it likely will be funneled into the stock market.
The no case:
• The Atlanta Fed projects 3.2% real GDP growth for Q1 ‘23.
• The passage of the massive infrastructure and inflation reduction spending bills should create jobs, which then becomes income that moves through the economy with a multiplier effect.
• Unemployment has remained at low levels and consumer confidence is holding steady.
• Consumer sentiment shows inflation expectations declining slightly from 3.8% to 3.6%.
• Real estate has remained steady with residential showing continued strength but commercial showing signs of stress.
We expect the markets to be bumpy for the next few months for a few reasons. International tension events from Russia, China or the Middle East can boil up at any time. The Fed’s willingness to soften rate hikes after several banks imploded appears to have quelled investors’ concerns. Inflation is declining—not by a lot, but it’s moving in the right direction. The political landscape cannot be discounted, as the push will be on to decrease inflation and interest rates. The jury is still out on the recession outlook, our view, it will arrive later this year, but be relatively mild.
We are maintaining a long-term perspective, backed by an appropriate asset allocation consistent with your goals. We are increasing our weighting to value-oriented, dividend-paying stocks and equity ETFs and capitalizing on relatively high short-term bond interest rates in fixed income portfolios. Equity ETFs give you exposure to most sectors (large cap, mid cap, small cap, and emerging markets) at a low cost.
As always, please do not hesitate to contact us with any questions.
Jonathan F. Kolle, CFA®
President, Chief Investment Officer
Daniel A. Morris, M.S.
Co-Chief Investment Officer
Joseph K. Champness
Director
Shawn R. Keane, CFP®
Vice-President
Cindy de Sainte Maresville, CFP®
Certified Financial Planner
Rusty Giles
Director of Marketing
James V. Kelly, CFA®
Director
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