Despite a challenging 2022, the first quarter of 2023 brought favorable gains to both the stock and bond markets. However, it was a tumultuous journey filled with unexpected twists and turns. The banking crisis, in particular, created uncertainty around Federal Reserve policy, sending waves throughout the market. Interestingly, the market also saw the revival of technology giants, previously faced with a downturn, which caused significant price surges. At the same time, growth stocks made a comeback, and dividend-paying stocks suffered. Meanwhile, bond investors shifted to safer territory, abandoning riskier debt. Moreover, there was a noticeable difference in how the stock and bond markets perceived the economic outlook.
During the first quarter, stocks were stuck in the range they’ve been trapped in for over six months, suggesting investors see little difference in the outlook for the economy or corporate profits despite the banking crisis. While earnings per share estimates of stocks have been falling in 2023 and potentially throughout 2024, the rate driving these metrics implies +10% growth. This implied growth rate is a ray of hope not to be ignored and reinforces our thoughts on not trying to time the market as the building block for the next bull market may very well be underway.
Within the bond market, investors sought the safety of U.S. Treasuries while shunning bonds with lower credit ratings.
The collapse of Silicon Valley Bank in mid-March dwarfed concerns over re-accelerating inflation and prompted a sharp rally in government bond markets. U.S. 10-year yield fell from 3.92% to 3.47%, with the two-year going from 4.82% to 4.03%.
Investors are understandably on edge as the Treasury yield-curve inversion persists, indicating troubling times ahead. Though not all inversions have led to bear markets, the historical precedents cause concern as short-term yields surpass their long-term counterparts for the fourth consecutive quarter.
The primary narrative in the financial markets centers around when and how a recession will occur. Historical indicators, such as housing data, paint a more complex picture. Typically, when new home starts are declining, a recession looks imminent. However, looking at a deeper level, a stronger correlation exists between construction payrolls and housing. Construction payrolls typically fall 8 to 10% before a recession begins. Construction payrolls are on the rise, with the increased demand for multi-family housing continuing to expand. Another concern centers around the availability of credit and liquidity. According to our financial modeling, the Fed’s policy still needs to be more restrictive to trigger a deep recession.
Throughout the past few months, the story of the economy has had many twists and turns. People were convinced a recession was on the horizon at the end of last year, but then a soft landing was predicted in January. Analysts changed their tune once again in February and called for a re-acceleration, only to be met with a banking crisis in March. Despite this turbulent narrative, stocks have managed to reverse course positively.
The bear market is now one year old. Where we go from here largely depends upon the Fed’s actions, earnings estimates, and the behavior of the bond market. Much of the headline news characterizes the cash deposits coming out of banks as a sign of illiquidity. However, most of this money is flowing into money markets, and we believe it will make its way into the stock market. Americans are still sitting on 1.5 trillion dollars in “excess savings.” We plan to stay the course and remain steadfast in maintaining defensive positions in our equity strategies. Our asset allocation strategy continues negotiating the tug-of-war of extreme fluctuations between stocks and bonds with poise.
