Q1 2023 Commentary

Q1 2023 Market Recap

 The financial markets overcame a barrage of negative news flow in the first quarter, as stocks and bonds both posted solid gains. The headlines ranged from not-so-good to somewhat scary, as we witnessed the second and third largest bank failures in U.S. history, revealing the impacts of tighter monetary policy in the banking sector. By quarter’s end, if one did not look or listen and avoided all of the noise in between, the market action would suggest everything was fine with the world.

 There was no shortage of volatility in the quarter reflecting the chaotic flow of news. The S&P 500 Volatility Index (VIX) traded in a wide range with market volatility peaking in March in concert with the bank failures. Following the Fed and U.S. Treasury intervention designed to alleviate market panic and avert a full-on banking crisis, the markets recovered some lost ground into the end of the quarter. With this backdrop, let’s review our key observations for the quarter and the impact on our outlook:

  • While the S&P 500 posted a nice gain of 7.5%, looking under the hood, some of the broader market indices did not fare quite as well. 
  • Inflation and Fed policy continue to be intertwined. Key components of inflation remain sticky, but the Fed will be watching the economy more closely in light of recent news in the banking sector.
  • The bond market stabilized in the first quarter with the recent bank failures leading to a rapid change in expectations for monetary policy.
  • If history is a guide, bank lending standards should tighten, leading to tighter credit conditions that could fuel further economic weakness.
  • The consumer squeeze continues to intensify with credit card balances growing at a rapid pace, while credit card delinquencies are on the rise.
  • Gold was a shining star in the first quarter, outperforming other precious metals and the commodities index in general.
A Closer Look at Stock Market Performance 

The S&P 500 is a capitalization weighted index ,which can be heavily influenced by the performance of the largest positions within the benchmark, typically referred to as the “Mega Caps”. Seven of the largest companies in the index, including Apple, Microsoft, Amazon, Google, Nvidia, Tesla, and Meta, make up nearly 23% of the benchmark weight and accounted for 90% of the return of the S&P 500 for the quarter. By comparison, the S&P 500 Equal-Weighted Index, which reflects an equal weighting of all 500 companies in the benchmark, was up only 2.9%. 

Similarly, reflecting that the broader market was not quite as strong, the S&P 600 Small Cap Index, representing US Small Cap stocks, was up a more modest 2.6%. Small Caps and the broader market were negatively impacted by the performance of financial and banking stocks (for obvious reasons) and economically sensitive companies. In addition, dividend and value oriented stocks, which significantly outperformed in 2022, struggled to keep pace with the S&P 500 in the first quarter. In many respects, the performance trends experienced in the first quarter reflected a reversal of what stocks were hit the hardest in 2022, meaning those baskets of stocks that were down the most in 2022 were up the most in Q1 2023. For example, led by the tech-oriented Mega Cap stocks, the Nasdaq 100 Index was up almost 21% in the first quarter, after falling by 29% in 2022.

Inflation and Fed Policy Updates

Inflation continues to subside, albeit at a snail’s pace, as services inflation remains stubbornly high. We are still far away from the Fed’s long-term inflation target of 2%, which is why the Fed raised rates 25 basis points at the last policy meeting in February. However, with additional indications of economic contraction and the emerging “banking crisis” in March, there are some signs that the Fed could hit the pause button on further rate hikes for the foreseeable future. Nonetheless, the Fed has made it clear that its number one priority is to make sure the rate of inflation continues to fall and is contained.

Bonds Post Solid Quarter

U.S. bonds rallied strongly in the first quarter, posting the best quarterly return since the start of the pandemic. While some positive economic data in February caused interest rates to move higher, the banking crisis in March led to a precipitous drop in rates as well as the expectations for future Fed rate increases. Prior to the crisis, the market was expecting approximately 0.75% of additional rate increases by the Fed, but by month’s end, the market was only pricing in 0.15% of future rate increases. This led to strong performance across most fixed-income assets, particularly longer duration Treasuries, as rates across both short and longer maturities plummeted. 

Implications of Recent Bank Failures

The failures of Silicon Valley, Signature, and First Republic Banks are revealing some of the emerging implications of the easy money bubble culminating in the post-pandemic era. In reversing the trend of easy monetary policy and increasing short-term interest rates, banks are having to deal with two key issues: 1) higher funding costs for bank deposits/liabilities; and 2) the markdown of assets or securities in the bank portfolios. These bank failures were not insignificant, as Silicon Valley and First Republic were the 16th and 14th largest banks in the country. In the case of First Republic, they experienced an outflow of deposits to the tune of $70 billion, creating the need for a massive infusion of capital to rescue the bank. 

Small and mid-sized regional banks are certainly feeling the brunt of the impact as the Regional Bank stocks declined 28% in the month of March alone. On a go forward basis, many wonder if this is the canary in the coal mine that leads to additional failures or some type of credit crisis. While that may be difficult to forecast, it is much easier to point to other implications. Because of the embedded securities losses in bank portfolios, which impacts bank capital ratios, banks should be more limited in the amount of loans that they can make. The chart below demonstrates the percentage of banks that are tightening underwriting standards for loans. Bottom line, tighter lending standards leads to fewer loans being made, which leads to less economic activity. The shaded areas show prior recessions during periods of tighter lending standards.

Consumer Spending Running Low on Fuel

Last month, we highlighted the significant ramp up in consumer credit card balances over the last four quarters and how that has propped up consumer spending, while the interest cost consumers are paying has been spiking as well. The logical conclusion is that consumer spending should continue to slow. Furthermore, we are witnessing an increase in the rate of delinquencies on this mountain of credit card debt, as per the chart below. Lastly, we are even seeing some stronger signs of softening in spending for luxury goods as well. For example, recently, Restoration Hardware released earnings guidance, lowering expectations for sales and earnings, stating: “Business conditions are anticipated to remain challenging for the “next several quarters” and maybe even longer due to a rapidly weakening housing market…”

The Bottom Line

The focus for the stock market seems to be shifting from inflation and Fed policy to the economy and the potential for any aftershocks from the bank crisis. While the Fed will remain vigilant in fighting inflation, we believe that the Fed has begun to acknowledge the signs of economic weakness and the impact of recent events in the banking system and that they will begin taking a more moderate approach to Fed Policy, as a result.

The first quarter delivered a sigh of relief with solid returns in the equity and fixed income markets. However, even with the rebound in equity prices we witnessed in the first quarter, we continue to maintain a cautious approach to equity positioning within our portfolios. Since the beginning of the year, we have been and continue to be more constructive on the fixed income markets now that economic growth and inflation are moderating. We expect bonds to play their traditional role of defense within the overall portfolio as the year progresses. In the near term, we should continue to see volatility remain above normal, while economic growth and corporate earnings trend downward, as the financial markets digest the full impact of the rate hikes on the economy. Nonetheless, our portfolios are constructed based upon client objectives, for the long term, and in a manner that will enable us to participate in market upside and help protect capital should the market experience any additional turbulence. As always, patience and discipline are keys to success in this type of environment. 


Important Information

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The statements contained herein are based upon the opinions of Bison Wealth, LLC (Bison) and the data available at the time of publication and are subject to change at any time without notice. This communication does not constitute investment advice and is for informational purposes only, is not intended to meet the objectives or suitability requirements of any specific individual or account, and does not provide a guarantee that the investment objective of any model will be met. An investor should assess his/ her own investment needs based on his/her own financial circumstances and investment objectives. Neither the information nor any opinions expressed herein should be construed as a solicitation or a recommendation by Bison or its affiliates to buy or sell any securities or investments or hire any specific manager. Bison prepared this update utilizing information from a variety of sources that it believes to be reliable. It is important to remember that there are risks inherent in any investment and that there is no assurance that any investment, asset class, style or index will provide positive performance over time. Diversification and strategic asset allocation do not guarantee a profit or protect against a loss in a declining markets. Past performance is not a guarantee of future results. All investments are subject to risk, including the loss of principal.

Index definitions: “U.S. Large Cap” represented by the S&P 500 Index. “U.S. Small Cap” represented by the S&P 600 Index. “International” represented by the MSCI Europe, Australasia, Far East (EAFE) Net Return Index. “Emerging” represented by the MSCI Emerging Markets Net Return Index. “U.S. Aggregate” represented by the Bloomberg U.S. Aggregate Bond Index. “Treasuries” represented by the Bloomberg U.S. Treasury Bond Index. “Short Term Bond” represented by the Bloomberg 1-5 year gov/credit Index. “U.S. High Yield” represented by the Bloomberg U.S. Corporate High Yield Index. “Real Estate” represented by the Dow Jones REIT Index. “Gold” represented by the LBMA Gold Price Index. “Bitcoin” represented by the Bitcoin Galaxy Index