Markets, and more importantly, investor expectations, fluctuated drastically throughout the first three months of 2023. Beaten down areas came out of the gates quickly as they forcefully rallied on optimism that global central banks would soon halt rates. This soft-landing hope quickly sputtered as markets faced a banking crisis and thoughts of tighter financial conditions leading to a larger than expected slowdown in the global economy entered frame. In the last trading days of the month, fears of contagion calmed, and investors will now look for clues on the condition of company’s balance sheets as we enter earnings season. So far, business earnings and the consumer have been holding up, however the lag effect in monetary policy could soon begin to work itself through the economy.
Q1 2023 Market Commentary
Despite turbulence domestic equities performance was strong. Digging into the indexes, it is clear that growth and mega cap names led the charge as the tech-heavy Nasdaq rose 16.8% compared to the S&P 500’s gain of 7% and the Dow Jones Industrial Average’s gain of only 0.4%. To further the point, 8 of 11 sectors underperformed the S&P 500 as Technology (+21.6%), Communications (+20.8%), and Consumer Discretionary (16.1%) were the only outperforming sectors. By contrast, Financials (-5.6%) were the largest laggard due to the banking crisis while Energy (-4.4%) and Health Care (-4.3%), two of the leading sectors of 2022, followed closely behind.
At the latest Fed meeting a few weeks ago, the committee voted on increasing the Fed Funds rate 0.25% while expressing caution on the recent banking crisis. The Fed is facing the dilemma of fighting still high inflation while at the same time risking further complications in the banking system and economy by continuing to raise rates. Even given the turmoil, Powell went against market pricing of cuts at the end of 2023 and reiterated “rate cuts are not in our base case” for the remainder of 2023. It is clear that the Fed will be extremely nimble and data dependent going forward, which further adds to the uncertainty on expectations for their policy path.
Markets are grappling with the idea that the enormous amount of Fed tightening could be contributing to a large slowdown in the economy and began to embed worries that earnings estimates would begin to be cut. The positive is that inflation might finally be coming down, yet the reasons might be due to a much less strong economy. Inflation remained elevated at 6% while the labor market remains stubbornly robust for the Fed as unemployment remains at 3.6%.
Foreign markets performed in line with their US counterparts as the MSCI ACWI ex US advanced 7%.
The region outperformed as technology, consumer discretionary, and communications led the gains. During the quarter we saw two separate 50bps hikes by the European Central Bank in their constant fight against inflation. Like the US, inflation remains sticky as consumer prices in the Eurozone rose 6.9% year over year, down from 8.5% in February.
Across the pond, the story for UK equities was the same as economically sensitive areas outperformed. Lagging GDP data showed the economy had not contracted at the end of 2022, contrary to market expectations. The most recent forecasts from the Bank of England show the country is expected to fall into a recession later in the year. Their inflation rate broke a 3-month stretch of decline with a surprise rise to 10.4% as the service sector remained strong. The MSCI UK All Cap was up 5.7%.
Emerging markets performed well in Q4, helped mostly by the outsized weight and outperformance in China amid the re-opening of the economy. Drilling down, the Czech Republic and Mexico notched the best gains. The MSCI Emerging Markets Index rose 4%.
The first quarter of 2023 was marked by several distinct episodes of volatility in the fixed-income market. Initially, yields eased to kick off the year on positive growth sentiment, providing a steady stream of positive returns throughout January and spilling into February. The calm descent of yields was then quickly reversed as resilient economic and employment data forced the potential path for inflation, and therefore interest rates to combat it, higher. Fed President Powell’s testimony to Congress reaffirmed market thinking as he implied the strong data could lead to a renewed increase in coming policy rate hikes. March’s banking panic, however, sent market rates screaming downward as fears of systemic damage, economic deterioration, and a lower projected path of Fed tightening brought investors looking for safety into bonds. Despite these drastic fluctuations, the broad fixed-income market recorded solid performance for the quarter, with the Bloomberg Global Aggregate gaining 3.01%.
With duration exposure generating most fixed income returns for the quarter, longer-dated bonds outperformed the shorter end, with the Bloomberg US Treasury 20+ Year Index leading all bond markets by returning 6.56%. The relative outperformance at the longer end generated a bull steepening in the curve and a significant reduction in the yield curve inversion that we have seen over the past 12-months.
Due to performance captured in the first two-thirds of the quarter, investment-grade corporate bonds outperformed their government bond counterparts, despite the banking and systemic concerns leading to a late widening in spreads. The high-yield space took a larger hit from the market stress as these bonds are more sensitive to economic conditions but kept pace with similar maturity government bonds. The Bloomberg US Corporate Bond Index rose 3.93% and the Bloomberg High Yield Index gained 3.57%
The cryptocurrency market made headlines with a roaring comeback after being beaten down during the FTX collapse and the 2022 bear market. The risk on trade early in the year brought crypto along for the ride and while the banking panic initially led to a sell-off, the market rebounded on thoughts that
crypto may be the answer to our banking problems. Bitcoin finished the quarter up over 65%, despite a sell-off during the banking panic.
Traditional commodities markets did not fare as well, with the broad S&P GSCI Index losing nearly 5%. The primary culprit for the losses was demand deterioration in oil markets, which caused Brent Crude to lose 7.7%. However, a flight towards safety and a pullback in real yields sent gold prices higher for the quarter. The S&P GSCI Copper Index gained 7.3%, primarily due to news tied to China's continued reopening.