Stocks stay resilient despite banking concerns
Higher yields in bonds begin to show benefits
The Fed remains hawkish on fighting inflation
After last year’s market declines provided investors with a sobering reacquaintance with bear markets, many hoped that a reset of the calendar might be the remedy for the tide to turn once again. Through the first three months of 2023, that has generally been the case, but the path and events that have led to this outcome would not generally conjure the image of a rebounding market. Despite continued (though moderating) high inflation, rhetoric around the Federal “debt ceiling” heating up, a steeply inverted yield curve, and an unforeseen crisis in regional banks, asset prices were broadly higher in the quarter.
The events of this quarter have provided yet another example of the difficulty in predicting markets in the short-term. For example, the closure of Silicon Valley Bank sent ripples of fear throughout the banking system. Despite this, the S&P 500 had a positive return from March 8 (the day before the bank became a headline news story) through the remainder of the month.1 While markets can confound and confuse in the short term, it is our opinion that having a long-term plan can help investors stay the course and maintain the discipline required to ignore the inevitable day-to-day noise in the markets to achieve their financial goals.
Economic Review & Outlook
The Federal Reserve continues to remain focused on reigning in inflation, even with the recent tumult in the markets caused by volatility in the regional banking industry. At their March meeting, the Fed raised the federal funds rate by another quarter of a percent, bringing the current target rate to a range of 4.75% - 5.00%.2
We believe that the Fed’s actions, while unprecedentedly aggressive, continue to appear effective. The Consumer Price Index (CPI), which peaked in June of last year (9.1%), rose by only 0.4% in February, a cumulative increase of 6% from the previous year.3 While inflation continues to remain well above the Fed’s long-term target rate of 2%, February was the eighth consecutive month of declines since last summer, providing some encouragement that tighter monetary conditions are having the desired effect on price levels.4
As we saw through most of last year, a perhaps unintended consequence of fighting inflation is the impact that higher interest rates have had on the value of investments, especially bonds. This came to light in the first quarter, particularly for financial institutions which use the relative safety of U.S. Treasuries to manage their cash balances and overall balance sheet exposures. The failure of Silicon Valley Bank had a myriad of causes but raises concerns on the difficulty some banks have had in mitigating risks arising from the speed at which interest rates have increased.
Fed policy may be most evident in the housing market, as rising interest rates have increased financing costs for both residential and commercial properties. With the supply of homes near historic lows, buyers are having to contend with a one-two punch of higher home prices and mortgage rates.5 This is especially painful for first-time buyers who have not benefitted from the growth in home equity experienced over the past several years. This has led to the longest duration month-to-month decline in single-family home sales since measurements started in 1968.6 However, there are now signs of sales volume beginning to pick up again. While sales were down almost 23% from a year ago, the number of homes purchased increased by 14.5% from January to February. This coincided with the first drop in the median home price in over a decade.7 While this is positive news, we believe the housing market will continue to remain tight until there is some combination of additional supply, cheaper financing, and lower pricing.
Bond Market Review & Outlook
|Bloomberg US Aggregate Bond Index||3.0%||3.0%|
|ICE BofA US High Yield Bond Index||3.7%||3.7%|
Return data provided by Morningstar Direct
After suffering their worst year on record in 2022 as measured by the Bloomberg US Aggregate Bond Index, bonds had positive returns in the first quarter of the year, bolstered by a combination of slight decreases in interest rates across most maturities as well as benefiting from higher yields created through 2022’s selloff.8
As a result of the Federal Reserve’s interest rate hikes, a number of cash management strategies suddenly find themselves with what we think are attractive yields, including money market funds and CDs. After experiencing the pain of last year’s bond market, many investors have started to wonder if they should remain invested in bonds if attractive yields can be earned without exposing themselves to interest rate risk. While many investors are well acquainted with the downside, interest rate sensitivity can also be a benefit for investors when rates drop. According to J.P. Morgan Asset Management, given the current yield curve environment, a hypothetical 1% decline in rates would create a larger upside than the downside created by an additional 1% increase in rates across all major bond sectors.9 This asymmetric return profile allows investors to reduce losses while increasing gains due to interest rate movements.
Additionally, we believe that investors should periodically evaluate the purpose of holding bonds in their portfolio. While income and lower relative risk are certainly major considerations, so too are the diversification benefits of equities and other asset classes. While 2022 had several idiosyncratic factors which reduced the low correlation which has historically existed between stocks and bonds, this first quarter has already shown that the market does continue to prioritize bonds in a “flight to safety”. This was evidenced by the 2-year Treasury yield dropping from 5.07% to 3.88% in a single week in response to the Silicon Valley Bank closure.10 While this example was a particularly volatile experience, the first quarter of 2023 has given many hope that the traditional relationship between stocks and bonds has returned to form.
Stock Market Review & Outlook
|Dow Jones Industrial Average||0.9%||0.9%|
|MSCI All Country World Index ex USA||6.9%||6.9%|
Return data provided by Morningstar Direct
In contrast to 2022, stocks had a positive return in the first quarter across most major indices. To us, what’s even more interesting has been the resurgence of growth stocks thus far in 2023 as evidenced by the NASDAQ Composite’s 20.8% return in these first three months of the year.11 In general, our opinion is that the economic outlook looks very similar today as it did through much of 2022, as evidenced by low, but positive GDP growth, high inflation, and a persistent debate over whether a “soft” or “hard landing” will occur. We believe it would then stand to reason that the market themes that worked in 2022, namely value stocks and more defensive sectors, would continue to outperform in 2023. However, the market can react to changing expectations of the future, even if the present looks consistent. The relative performance of growth and value stocks over the past 15 months is yet another reminder of the difficulty in timing themes in the market over the short term.
A theme that has continued from 2022 is the relative outperformance of international stocks. Since the beginning of 2022, international stocks as measured by the MSCI All Country World ex USA Index have outperformed US stocks as measured by the Russell 3000.12 As seen in the chart from J.P. Morgan Asset Management, valuations of US stocks remain very close to historical 25-year averages while stocks in other areas of the world, notably Japan, Europe, and China, continue to look relatively undervalued.
It is our view that the first three months of 2023 have reiterated the importance of broad diversification across the global equity universe. Whether looking at US vs. international, growth vs. value, or through any other market lens, diversification allows investors to potentially take advantage of short-term themes while managing risk along the way.
Alternative Investments & Hybrids Review & Outlook
|Alternatives (Morningstar Category)||0.1%||0.1%|
|Alternatives (Real Assets)||1.8%||1.8%|
|Hybrids (Morningstar Category)||3.5%||3.5%|
Alternative investments continued to provide multiple benefits to investor portfolios throughout the quarter. Alternatives, which can include investments in real estate, private equity, and hedge funds, for example, have the potential to improve portfolios by providing opportunities for current income, asset diversification, and yield enhancement while having low correlations to traditional stocks and bonds.
However, unlike traditional investments where returns are largely driven from asset allocation (e.g., a 60/40 portfolio of stocks and bonds), alternative investment returns are heavily dependent upon which managers/strategies are selected. The below chart from J.P. Morgan Asset Management highlights that the range of outcomes for alternative investment managers are much wider than strategies focused on traditional stocks and bonds.13
While alternative investments are not suitable for all investors, the market environment since the beginning of 2022 has demonstrated the benefits an allocation to this asset class can provide. However, we believe that investors need to incorporate a rigorous due diligence process for any allocation to alternative investments as the specific strategies selected can have a large impact on investment outcomes.
The author Joyce Meyer once wrote, “Patience is not simply the ability to wait – it’s how we behave while we’re waiting.” (Source: Joyce Meyer, Battlefield of the Mind: Winning the Battle in Your Mind) Today, technological advancements have made patience a skill of the past. Would you like to see the new show everyone’s talking about? Open your streaming service of choice, and it will be playing in your home within seconds. Did you just realize you need new shoes for a spur-of-the-moment trip? They can be on your front porch tomorrow. Are you trying to avoid a thirty-minute wait at your favorite restaurant? Chances are you can add your name to the list on an app before you’ve even left your home.
While convenient, these modern luxuries can make investing feel even more foreign than it did in the past. In a world where you can have almost anything you desire in the blink of an eye; many successful investment outcomes have not followed suit. In our experience, the markets ask for patience not in today’s sense of minutes and hours but in the generational sense of years and decades. Investors are now 15 months removed from the last all-time highs in the S&P 500, and it’s natural to feel impatient for the market to resume its positive general trend. However, with a financial plan in place and a little bit of patience, we believe investors can appreciate the market’s long-term benefits while ignoring the positive and negative minutia in the interim.
This information is for educational purposes and is not intended to provide, and should not be relied upon for, accounting, legal, tax, insurance, or investment advice. This does not constitute an offer to provide any services, nor a solicitation to purchase securities. The contents are not intended to be advice tailored to any particular person or situation. We believe the information provided is accurate and reliable, but do not warrant it as to completeness or accuracy. This information may include opinions or forecasts, including investment strategies and economic and market conditions; however, there is no guarantee that such opinions or forecasts will prove to be correct, and they also may change without notice. We encourage you to speak with a qualified professional regarding your scenario and the then-current applicable laws and rules.
Different types of investments involve degrees of risk. The future performance of any investment or wealth management strategy, including those recommended by us, may not be profitable or suitable or prove successful. Past performance is not indicative of future results. One cannot invest directly in an index or benchmark, and those do not reflect the deduction of various fees that would diminish results. Any index or benchmark performance figures are for comparison purposes only, and client account holdings will not directly correspond to any such data.
Our clients must, in writing, advise us of personal, financial, or investment objective changes and any restrictions desired on our services so that we may re-evaluate any previous recommendations and adjust our advisory services as needed. For current clients, please advise us immediately if you are not receiving monthly account statements from your custodian. We encourage you to compare your custodial statements to any information we provide to you.
- Return data provided by Morningstar Direct.
- J.P. Morgan Asset Management Guide to the Markets as of March 31, 2023.
- J.P. Morgan Asset Management Guide to the Markets as of March 31, 2023. Assumes a parallel shift in the yield curve.
- Return data provided by Morningstar Direct.
- Return data provided by Morningstar Direct.
- J.P. Morgan Asset Management Guide to Alternatives as of February 28, 2023