At the end of the quarter the Standard and Poor’s 500 was at 4,056, up 7.5% . The ten-year Treasury bond yield was at 3.471. It has yielded 3% over the three-month interval. The effective Fed Fund rate was 4.83% on March 31, 2023.
Equity indices rose in January and, despite volatility over the three-month period, ended the quarter positively. Fixed income markets were similarly positive. Unfolding economic data evidenced a decline in the Consumer Price Index (CPI). In February, U.S. headline inflation was at 6.0% versus its peak of 8.9% in June 2022. Housing cost does represent over 70% of the price increase reflected in the most recent inflation data. Observational data, however, suggests a slowing in the pace of price increase within this sector. Admittedly, CPI data continues to suggest differently. This difference can be explained by the lag in data reporting reflected in CPI data.
Core inflation data does not reflect as aggressive a decline as does headline inflation data. The Federal Reserve may well be required to continue to increase interest rates and, once a terminal rate is achieved, hold that rate for a more extended period of time until inflation reverts to or approximates the Fed target of 2%.
The information that can be extracted from economic data suggests that the economy remains resilient and can sustain further interest rate tightening. The flip side, however, is that the same data indicates that the pace of inflation growth is such as to warrant further increase in interest rates in an effort to slow economic growth.
Speculation as to what might ‘break’ in the face of recent interest rate increases had its answer in the failure of the San Francisco based Silicon Valley Bank (SVB) in March. Similar but less disruptive bank runs occurred at New York based Republic Bank, a large regional bank, and the very large Swiss banking institution, Credit Suisse. All contributed to increased market volatility and losses in equity positions across financial markets. Up to this point confidence had existed in the resilience of the financial system despite dramatic increases in Federal Reserve bank interest rates .
The run that occurred on a few banks now appears a-typical to the banking industry as a whole. Investors are less concerned of an impending contagion among banks and the prospect of wide spread bank failures. Client deposit withdrawals highlighted the dislocation between demand deposits and certain banks’ long term investment strategies. Withdrawals necessitated liquidating low interest rate bearing securities at a price loss in an escalating interest rate environment. These losses undermined the capital positions of the affected banks.
Fed Chairman Jerome Powell acknowledged that a tightening of credit availability by banks in the wake of SVB and other bank failures may have the positive benefit of making credit more restrictive and thereby slowing economic activity. This may have the positive impact of reducing the need for further interest rates increases by the Fed.
Interest rates climbed in the early part of the quarter. The Federal Reserve increased interest rates by 0.25% in March despite the overhang of the banking turmoil. The European Central bank raised interest rates by 0.25%. The Bank of England increased its policy rate by 0.25% in the face of an increase in inflation both headline and core by 10.4% and 6.2% respectively. The People’s Bank of China reduced its reserve requirement ratio by 0.25% despite the resurgence of economic activity following the elimination of COVID restrictions. By quarter end rates had ameliorated buoyed by seemingly weakened economic data in some part attributable to the turmoil that affected the banking industry earlier in the month.
The US employment market remains stubbornly strong, great news for the Biden Administration but negative news for those hoping to see evidence that the economy is slowing and inflation will soon reach levels consistent with the Feds policy objective. Average hourly earnings continue to increase though the pace of that increase has slowed.
China’s rapid abandonment of its zero COVID policy boosted economic growth in-country as well as globally. Low inflation has allowed the People’s Bank of China to avoid restrictive monetary policy. This is contributing to the country’s economic rebound across all sectors.
European manufactured product sales are up boosted by the resurgence of the Chinese economy .
The Ukraine war continues to cast a deep shadow over European economic growth. Germany and France did post strong Q-1 economic activity. Euro zone inflation declined on a year-to-year basis. Core inflation did increase from 5.2% to 5.6%. In March the French government extended the country’s retirement age by 2-years. Labor strikes and nation-wide demonstrations followed and continues. Across the Euro Zone Consumer confidence remains positive as does data for the composite purchasing manager’s index.
A warmer than expected winter in Europe undermined projections of energy dislocations made in the summer months of 2022. It is unclear whether Europe will be able to repeat this success story in 2023. Energy prices are at a premium to what they were before the Russia-Ukraine war. European energy storage facilities remain relatively full and countries continue to be planful as to how best to diversify the sourcing and product mix of energy supplies.
The below illustrates the breadth of change in the domestic equity and debt markets over the past three months.
|Q-1 2022||Q-2 2022||Q-3 2022||Q-4 2022||Q-1 2023|
|US S&P 500**||-4.6%||-16.1%||-4.9%||7.6%||7.5%|
|Growth (MSCI World Growth)**||-9.6%||-21.1%||-5.0%||4.8%||15.2%|
|Value (MSCI World Value)**||-0.5%||-11.46%||-7.1%||14.9%||1.1%|
|Small Cap (MSCI World Small Cap)**||-6.4%||-17.1%||-5.2%||10.9%||4.4%|
|Barclays US Aggregate Bond Index (USD)||-2.8%||-3.2%||-4.3%||-0.5%||2.5%|
**Asset Class Data: JP Morgan, Quarterly Review of Markets
All client portfolio were reviewed over the course of the quarter. Where appropriate portfolios were further diversified in an effort to better position investments to be able to take advantage of an uptick in share prices when markets eventually rally. New money was invested in money market funds or ,where equity diversification strategy recommended otherwise, invested in stock portfolios (mutual and ETF funds) with industrial, materials and market-defensive sector exposure.
Economic and geopolitical uncertainties will continue to complicate central bank’s interest rate policies designed to fight inflation. Policy actions influence interest rates, company valuations, and stock prices. This suggests a need for continuing a relatively conservative investment posture given the uncertainty as to how unfolding developments may impact markets in subsequent quarters of 2023.
Client portfolios do continue to retain exposure to the growth sectors specifically technology and health care. In some instances over-weight positions have been trimmed to allow for broader market exposure in the fore mentioned sectors. We believe that technology and health care will continue to be leading sectors of the economy for the foreseeable future and that these sectors will rebound favorably once markets rally.
Clients with investments pursuing dividend and or interest returns may continue to see losses in the market price of these holdings as prices adjust to changes in interest rates. Investors in these securities should, however, continue to receive the interest or dividend returns expected at the time the investments were made. The share price of these portfolios, similar to those of equity investments, will right themselves over time.
 Vincent Juvyns, J.P.Morgan Quarterly Market Review, 03-04-2023 https://am.jpmorgan.com/gb/en/asset-management/adv/insights/market-insights/market-updates/monthly-market-review/