Reflecting on Q1 2023 Markets
The markets were on a bit of a rollercoaster during the first quarter of 2023. Continued elevated inflation, and the actions by the Federal Reserve to bring it under control, dominated the headlines. Although the manufacturing sector of the economy is contracting, the services sector continued to grow, but remains plagued by wage pressures. The labor market showed continued strength during the quarter as the unemployment rate has ranged between 3.4% and 3.6% for the past twelve months. Concerns over weaker earnings reports and disappointing guidance from companies also weighed on investor sentiment during the quarter.
January saw strong performance from all of the major equity indices with the S&P 500 up 6.3% and the NASDAQ up a whopping 10.7%. February saw the equity markets turn slightly negative for the month on the back of huge January employment gains and hotter than expected inflation data, which lead the markets to price in more rate hikes from the Federal Reserve. March saw the collapse of SVB Bank and Signature Bank and a lack of confidence in the overall banking sector. After speedy intervention by the Federal Reserve, FDIC, US Treasury, and large systemically important institutions, led by J.P. Morgan, stability in the financial sector was restored and the equity markets rebounded.
For the quarter, large cap domestic stocks outperformed small cap domestic stocks with the S&P 500 returning 7.5% and the Russell 2000 returning 2.7%. The NASDAQ returned 17.1% for the quarter, snapping a four-quarter losing streak. Within the S&P 500, the Information Technology sector was the best performer at 21.8%, followed by Communications Services at 20.5%, and Consumer Discretionary at 16.1%. Weakness came from the Financial sector at -5.6%, Energy at -4.7%, and Real Estate at -4.3%. International stocks slightly outperformed US stocks with the MSCI EAFE returning 7.65%.
Fixed income markets rebounded during the quarter and returned 2.96%, according to the Bloomberg US Aggregate Bond Index. Corporate bonds outperformed US Treasuries, and longer-term bonds outperformed shorter maturities, as yields on the longer-dated bonds fell during the quarter. Shorter-term US Treasuries (T-Bills), those ranging from 1- to 6-months, saw their rates rise during the quarter an average of 34.4 basis points (0.34%), while US Treasures from 2- to 30- years fell an average of 36 basis points (0.36%). This steepening of the US Treasury yield curve reflects the “flight-to-quality” that arose out of the issues plaguing the financial sector as well as the markets expectation that interest rates will be lower in the future.
The Federal Reserve (Fed) continued along its rate hiking path, raising its target rate 25 basis points (1/4%) at each of its meetings in February and March, moving the rate to 4.75% to 5.0%. In their announcement, the Committee noted that “inflation remains elevated” and that they remain focused on attaining their target of 2% inflation in the longer run. Given that as of February, inflation as measured by PCE, was still running at 5.0%, the Fed noted that “the Committee anticipates that some additional firming may be appropriate.” Currently the market is expecting the Fed to raise rates one last time by 25 basis points (1/4%) at its May 3rd meeting and hold there for at least six months. Although the Fed has not commented on the possibility of any rate cuts at this point, the market is pricing in a few to occur in the 4th quarter of 2023.
Uncertainty about the coming months remains elevated, but given the stabilization within the banking sector after recent bank failures, the market’s focus is shifting back to inflation and the Fed. As the economy continues to show signs of slowing, expectations for a recession in the US have risen. We believe concerns about recession are valid and are maintaining a defensive investment posture. As the landscape evolves and the impact of monetary policy and the instability in the banking sector become clearer, we anticipate that markets will gain confidence.