Quarterly Update

The first quarter (Q1) of 2023 ended well for stocks and bonds, making for the second positive quarter in a row. It was a nerve-wracking time for investors, however, as bad news seemed to continually outweigh the good.

Here’s a roundup of how major markets performed during the quarter:

• US Large Cap Stocks: up 7.5%
• US Small Cap Stocks: up 2.7%
• US Core Bonds: up 3.2%
• Developed Foreign Markets: up 9%
• Emerging Markets: up 4.1%

It’s been a rough ride for investors in recent quarters, and especially those with a moderate risk tolerance who hold stocks in their portfolio but also a sizeable portion in bonds. Both asset classes were down last year, so it’s great to see positive returns to start 2023. Those returns weren’t easy to come by. Whether it was continued news about inflation and how much and for how long the Fed would keep raising interest rates, mixed with bank failures during March, the news cycle played havoc with investor sentiment throughout the quarter.

Across markets, tech stocks that took a beating last year were up the most during Q1. Chipmaker NVIDIA, Meta (the parent of Facebook), and Tesla were each up over 60% by quarter’s end but the latter two stocks and the sector as a whole are still down over the past year. There are a variety of explanations for this positive turn but for sectors like Tech and Communication Services this was primarily a snapback as sentiment shifted around the likelihood for a softer recession than originally feared.

The worst performing sector was Financials, down almost 6% in Q1, for reasons obvious to anyone paying even remote attention. While inflation was still a foundational theme for the quarter, early March greeted us with surprise news that Silicon Valley Bank, a large but “local” CA institution, had been seized by regulators following a bank run lasting just a few days. Then another, Signature Bank of NY, was shuttered and quickly everyone everywhere was waiting for the next shoe to drop while checking up on their federal deposit insurance. A short time later we had news that another publicly traded bank, First Republic out of San Francisco, was on the ropes. The Fed and others quickly came to the banking system’s rescue, buoyed First Republic, and generally settled everyone down. The result, at least in part, was the positive broad market performance posted above.

Another result of March’s mini banking crisis was a major shift in the outlook for inflation, Fed interest rate moves, and recession. Inflation rose quickly last year before peaking midsummer. Since then inflation has been trailing off every single month. Unfortunately inflation was still about 6% as of February, 4% higher than the Fed’s target. During Q1 this meant that the Fed raised short-term interest rates by 0.50% spread over two meetings, a slower pace than in prior months. But given reverberations from the bank failures already mentioned, the Fed is expected to slow its pace further, or even stop raising rates, as it waits to see how these events might help reduce inflation.

Potentially impacting the Fed’s assumed “dovish” turn is a realization that they’ve already done enough in the last year to slow the economy, perhaps too much. A variety of indicators suggest that we may already be in recession or might be in one soon (as a reminder, recessions are only called well after they’ve started). GDP data has been weakening and leading economic indicators are pointing to recession. The yield curve that we’ve discussed elsewhere is also deeply inverted and that’s always indicated a coming recession when the inversion is this large. And specific sectors of the economy, such as housing, are already there on a national basis.

On the bond side of your portfolio, expectations for a gentler Fed helped bonds recover a bit during Q1, with the primary bond index returning over 3% for the quarter. Bond investors are now assuming the Fed starts lowering rates during the second half of this year, based on the recession risks already mentioned. Only time will tell who’s right, of course, but it’s always interesting to watch bond investors trying to anticipate Fed policy.

While all this might sound downright gloomy for investors, April has typically been one of the strongest months of the year for stocks. And, according to Bespoke Investment Group, year three of a presidential election cycle is often quite strong as well. Beyond that, and from a contrarian perspective, market sentiment is abysmal and that typically bottoms before stocks start a longer positive run. We could be looking at a seemingly ironic situation where our investments start doing better as the broader economy starts doing worse, part of the normal long-term cycle.

So what should we be doing in this sort of environment? The news cycle will continue to be crazy, but we should keep charging ahead with our investments while managing risk in a prudent way. And with the rest of our personal finances we should take stock as we plan for recession. Evaluate your cash needs and review your personal liquidity structure. Try to pay down any higher-rate or variable debt and avoid taking on new debts if possible. The recession may be mild by historical standards but, whatever the length and severity, it’s best to plan ahead anyway. As always, we’re here to help in this process.

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