In this latest installment of our newsletter, we share our observations of the markets and the economy in the first quarter of 2023. Click here to go to the full report on our website. Following are the highlights:
- Stock and bond markets proved far more resilient in the first quarter of 2023 than most investors expected, though it was not without considerable choppiness along the way.
- The S&P 500 Index posted a surprisingly strong 7.5% total return in the first quarter of 2023, while the tech-heavy Nasdaq saw an even better recovery from last year’s losses, returning 17% for the quarter, its best quarter since the second quarter of 2020.
- The Bloomberg Aggregate Bond Index also returned a positive 3.0% in the first quarter, as long-term interest rates declined, sending bond prices higher. The yield on the 10-year Treasury note, which influences everything from mortgage rates to car loans, fell to 3.5% by quarter-end from 3.8% at the end of 2022.
- The shock to the banking system by the sudden collapse of SVB in mid-March sent some financial stocks down 30% or more for the month, though the contagion hit mostly smaller, regional banks while larger, money-center banks fared much better. For the quarter, the S&P Regional Banking ETF was down 25%, while the broader Financial Sector ETF was off just 6.5%.
- The heightened risk to the financial system from the bank failures likely impacted the Fed’s decision to raise short-term interest rates by just 0.25% in March, despite an expected increase of 0.50% earlier in the month. The Fed also softened its language regarding future rate increases by omitting a prior forecast for “ongoing increases.” This has raised hope among investors that the Fed may be ready to pause its rate raising campaign, despite the persistence of inflation.
- Notwithstanding the persistence of high inflation and slowing economic growth, there has been some positive economic data so far in 2023. The Atlanta Fed projects first quarter GDP growth of 2.2%, which, while down from fourth quarter GDP growth of 2.6%, nonetheless indicates a growing economy.
- The labor market also remains robust, although slowing. The U.S. economy added 236,000 new jobs in March, roughly in line with expectations. The unemployment rate slipped to 3.5% in March from 3.6% in February, and the labor force participation rate continued to rise, which is considered a positive. The U.S. has added more than one million new jobs in the first three months of this year.
- But recession fears are rising. The Fed recently lowered its forecast for full-year 2023 GDP growth to just 0.4%. Given that estimates for Q1 GDP growth are in the range of 1.5%-2.5%, this suggests that the U.S. could see negative GDP growth in the coming quarters. Recession is generally defined as two consecutive quarters of negative GDP growth.
- Finally, corporate earnings are contracting. S&P 500 earnings declined 4.6% in the fourth quarter of 2022 and are forecasted to decline again in the first quarter of 2023.
- Still, some argue that a recession is not inevitable. Those in that camp point out that inflation appears to have peaked, supply-chain woes have eased, China has re-opened its economy, and oil prices remain low. We’ll see who is right.
- Given all the uncertainties, our outlook for the economy and markets is mixed. We remain cautious on equities in the near term. Stock valuations, as measured by the S&P 500 Index, are neither overly expensive, nor are they cheap. We expect market volatility to remain elevated until there is more clarity on interest rates, inflation, corporate earnings, and world economic growth.
- While we are maintaining our long-term, value-oriented investment philosophy, we have taken a more cautious view of equity markets for the near term. Instead, beginning last fall, we have been deploying uninvested cash in short-term U.S. Treasuries at attractive, low-risk annualized yields of 4.5% – 5%.
- Once the Fed signals that it is pulling back from its aggressive rate tightening, and economic growth and corporate profits have stabilized, we will resume deploying cash in long-term equities.
- We continue to believe that our disciplined, active approach to individual security selection is more cost effective, tax efficient, and offers better long-term return potential over a full market cycle for our clients.
The Edgemoor Team
