The Quarter in Review | 1Q 2023
Global stocks gained nearly 7 percent in the first quarter, continuing their upward momentum that began in the fourth quarter of last year. Market volatility was relatively muted until March, when concerns about the stability of the banking sector made headlines. Following last year when value stocks beat growth by 20 percent, the first quarter saw value stocks lag growth by 12 percent.
Information technology names led for the quarter, lifting the returns of large growth stocks. Less profitable growth stocks especially outperformed, with stocks like Nvidia that returned 90 percent.
Energy stocks, many of which were still within the value side of the market despite a strong run-up last year, dropped by -3.0 percent. Financials, after being hit hard in March, ended the quarter down - 1.8 percent.
Small cap stocks generally underperformed, especially in the US, but not universally. While large cap stocks with lower profitability generally outperformed, the opposite was true in small caps where higher profitability stocks outperformed.
FIXED INCOME
Despite turmoil in the banking sector, the Federal Reserve (Fed) continued to raise rates for the ninth and tenth time respectively. However, it recently signaled that a pause in future rate increases is a possibility. Yields on high credit longer term quality bonds fell sharply as investors sought perceived safe havens. Thus, for the quarter the Bloomberg U.S. Government Bond Long Index had the highest returns, up +6.16 percent for the period. The US Aggregate Bond Index was up +2.96 percent respectively.
Short Term Treasury yields fell as the market started to price in the expectation (really just hope) that the Fed would actually cut rates later this year. Even with the fall in short term yields, the yield curve remained inverted, where short term rates are higher than longer term.
ALTERNATIVES
Commodities continued their decline from previous quarters with the Bloomberg Commodity Total Return Index down -5.36 percent for the period. Nickel and Natural Gas were the worst performers for the quarter, returning -50.9 and -21.4 percent respectively.
After a terrible 2022, U.S. Real Estate Investment Trusts (REITs) bounced back returning a positive +2.77 percent for the quarter.
ECONOMY
The labor market is strong and continues to be a bright spot that is inconsistent with the consensus forecast of an imminent recession. As noted in the chart below, the unemployment rate stood at 3.4 percent as of April 30th, just 0.1 percent above the 50 year low achieved in 2019 right before the COVID pandemic hit. With roughly 80 percent of our workforce in service-related businesses, many companies are still looking for good talent making unemployment more stable than expected.
In addition, we are seeing a trend of “onshoring”. COVID related global supply chain challenges have pushed more companies to bring manufacturing back to the U.S. For the first time since 1970s, U.S. manufacturing is above prior peak levels and appears poised for further growth. Recent laws such as the CHIPS Act have resulted in more than $200 Billion of announced domestic semiconductor manufacturing spend since 2020.
However, the broader economy is losing momentum. Job openings have come down, overtime hours and temporary staffing employment have dropped back to where they were two years ago. Outside of the semiconductor industry, business spending is expected to pull back due to recessionary worries. Rising costs, rather than deteriorating sales have caused weakness in earnings. Earnings of the S&P500 companies declined over 10 percent from the same period a year ago. Any recession would lead to a further decline in profits. The University of Michigan consumer survey readings are ominous. Spending intentions by the consumer are below the worst level among all recessions since 1982.
Even though inflation is on the decline, coming in at 4.9 percent for April down from a high of 9.1 percent in July, costs are still elevated but starting to cool with energy prices declining each month since the middle of 2022. In all likelihood, it will be mid to late 2024 before interest rates fall back into the 2 to 3 percent range targeted by the Fed. The fallout from the recent banking crisis will likely accelerate the tightening in credit conditions.
The Fed was clearly “behind the curve” in reacting to inflation which began in earnest mid 2021. As noted on the chart below, the 500 basis points of increases over the last year typically happen over a three or even four-year period. There have been 14 rate-hiking cycles since World War II and 11 of them caused a recession. The three instances when rate hikes did not trigger a recession was when the Fed stopped tightening before the yield curve became inverted (rate curve has been inverted now for well over a ye
LOOKING FORWARD
Looking ahead, equities may face further trials. Volatility continues to challenge investors and the first quarter was no different. On Friday, March 10th, while many were focused on the NCAA basketball tournament, regulators took control of Silicon Valley Bank as a run on the bank unfolded. Two days later, regulators took control of a second lender, Signature Bank. On May 1, First Republic Bank was sold in a FDIC managed fire sale to JPMorgan Chase. With increasing anxiety, many investors are eyeing their portfolios for exposure to these and other regional banks.
At times like these, instead of panicking, the best action is to instead turn to your investment plan. Your plan is designed with your long-term goals in mind and is based on principles that you can stick with, given your personal risk tolerances. While every investor’s plan is different, ignoring headlines and focusing on time-tested principles can help avoid making shortsighted missteps.
Uncertainty Is Unavoidable Remember that uncertainty is nothing new and investing comes with risks. Consider the events of the last three years alone: a global pandemic, the Russian invasion of Ukraine, spiking inflation, and ongoing recession fears. In other words, it may have seemed as if there were plenty of reasons to panic. Despite these concerns, for the three years ending February 28, 2023, the Russell 3000 Index (a broad market-capitalization-weighted index of public US companies) returned an annualized 11.79 percent, slightly outpacing its average annualized returns of 11.65 percent since inception in January 1979. The past three years certainly make a case for weathering short-term ups and downs and sticking with your plan.
Market Timing Is Futile Inevitably, when events turn bleak and headlines warn that the worst is to come, some investors’ thoughts turn to market timing. The idea of using short-term strategies to avoid near-term pain without missing out on long-term gains is seductive, but research repeatedly demonstrates that timing strategies are not effective. The impact of miscalculating your timing strategy can far outweigh the perceived benefits.
Diversification Is Your Friend Nobel laureate Merton Miller famously used to say, “Diversification is your friend.” While not all risks—including a systemic risk such as an economic recession, can be diversified away, diversification is still an incredibly effective tool for reducing many risks investors face.
In particular, diversification can reduce the potential pain caused by the poor performance of a single company, industry, or country. As of February 28, Silicon Valley Bank (SIVB) represented just 0.04 percent of the Russell 3000, while regional banks in total represented less than 1.70 percent.
When the unexpected happens, many investors feel like they should be doing something with their portfolios. Often, headlines and pundits stoke these sentiments with predictions of more doom and gloom. For the long-term investor, however, planning for what can happen is far more powerful than trying to predict what will happen.
Remember, we’re here to help. This also is where the time invested upfront with each of you shows its value. Formulating a solid and adaptable financial plan together and discussing liquidity, cash flows, and reserves, provides the solid footing needed for times like these with many changing facets.
We appreciate the opportunity to work with each of you. We recognize that each client’s situation is unique and incorporates different factors into their investment and financial plan.
As always, if you have any questions or concerns about current market trends and the impact on your personal situation and plan, please contact us and we would be happy to discuss.
Please follow this link to read the complete Quarterly Market Review (QMR) - Q1 2023.