1st Quarter of 2023 Economic and Market Commentary

1st Quarter of 2023 Economic and Market Commentary

| April 19, 2023

March Madness arrived in a form beyond the annual college basketball tournaments. On March 10th, Silicon Valley Bank was taken over by the FDIC and became the second largest bank failure in U.S. history (second only to Washington Mutual in 2008). The bank had grown substantially over the last few years – 86% in 2021 alone – as the technology sector of the economy had done well. With its new deposits from tech companies and entrepreneurs, the bank allocated those deposits toward “safe” assets like U.S. Treasurys.  But with interest rates rising rapidly last year, those bonds fell in value. When SVB announced a $1.8 billion loss in value on those U.S. Treasuries, a classic bank run ensued, and the fear of contagion hit the markets.  


Crypto-friendly bank Silvergate Capital soon followed and banks such as First Republic, Credit Suisse and Deutsche Bank dominated the headlines for potential contagion. Despite the uncertainty in the banking sector, the S&P 500 ended March up 4% for the month. In many ways, lessons from the 2008 financial crisis helped to avoid a further crisis. The Federal Reserve stepped in to guarantee deposits above the $250,000 FDIC insured limits and/or broker mergers and sales where needed. Generally, larger banks had already been well-capitalized and were tightening their lending standards in recent months. Nevertheless, the concern of a moral hazard will still exist and future regulatory pressures on banks could stall their growth prospects in the near term.


The timing of these events put a heightened focus on the March 22 Federal Reserve announcement regarding interest rates. Inflation has continued to fall, from 6.4% in December to 6.0% in February, but it’s still above the Fed’s target of 2.0%. Prior to the SVB failure, some expected that the Fed would raise interest rates by another 0.5% to further temper inflation. Amidst the banking crisis, many expected the Fed to halt rate hikes given that previous increases, in part, caused the SVB issues. In the end, the Federal Reserve did raise rates by 0.25%, bringing overall short-term interest rates to a level not seen since 2005. The prevailing thought now is that there is a 50/50 chance that the Fed either raises rates one more time in May or halts the rate hikes altogether given the falling inflation figures. 


1st Quarter 2023 Asset Class Returns

Except for commodities which declined, all other asset classes carried over the positive momentum generated at the end of last year. Economic indicators around consumer spending and production have been exceeding expectations. New jobs reports this quarter beat consensus estimates, shaking off continued layoff announcements from technology companies and leaving unemployment at just 3.5%. However, recent financial data suggests that a recession may be imminent, if not already underway.  

As shown in the table, Developed Market Equities (international stocks) are slightly outperforming U.S. equities.  This is particularly apparent in Europe where the greatest fears about energy shortages from the Russia-Ukraine conflict have not come to fruition due to a milder than expected winter. 


The strong start in equity markets serves as a reminder to rebalance portfolios amidst the headwinds that are expected during the remainder of the year. Continued efforts to bring down the federal deficit and the resumption of student loan payments this summer will have a drag effect on the overall economy. The housing market is still in flux due to higher mortgage rates: home prices are down 1.1% year over year while the number of homes sold were down 22.1%. These have led to a decline in single-family housing starts, but higher rents have led to an increase in multi-family housing starts. 


Inflation and recession fears remain the dominant global economic story for now, but a fraying geopolitical environment between the U.S. and China and wide disagreements over economic and social policies in Washington D.C. may “trump” everything else, perhaps by the end of this quarter.


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