The first quarter was an eventful one, as markets continued to digest interest rate increases and rebound from the October 2022 lows. While the S&P 500 is up 15% from those lows (and up 7.5% in the first quarter of 2023 alone), it's still 14% below the highs reached in December 2021. Just because it bears repeating, the S&P 500 is up 7.5% to start 2023, in spite of the headlines about inflation, interest rates, and banking concerns (which we discussed in detail in this earlier note). International equities also had a strong start to 2023, with developed markets (as measured by the MSCI EAFE Index) returning 8.6% and emerging markets (as measured by the MSCI EM Index) returning 4%. If any quarter is indicative of the difficulty of timing markets, it is the one we just lived through.
As we move into the second quarter and beyond, I'd like to touch on the three major topics moving markets: Inflation, Banks, and Interest Rates.
April’s CPI data showed a continued drop in inflation, with core inflation decreasing to a 5% annualized rate and 5.6% excluding food and energy.
While this is undoubtedly trending in the proper direction, the data itself is still noisy, best exemplified with gasoline prices dropping by 17.4% while food prices increased 8.5% over the last 12 months. Until these wild category swings subside, it will be hard to tell whether this is a signal of things to come, or just noise in the data.
The first quarter saw the second and third largest bank failures in history, as both Silicon Valley Bank and Signature Bank of New York were placed into FDIC receivership on the same weekend in March. Just a week later, Credit Suisse, the Swiss bank founded in 1856, merged with its rival UBS in a Swiss Central Bank orchestrated transaction the likes of which financial markets haven’t encountered since the 2008 financial crisis.
While concerns remain, we are seeing signs of improvement, as demand for liquidity from the Federal Reserve’s emergency lending facilities continues decreasing. If anything, the banking industry proved its resilience in the face of this recent crisis, and policymakers proved capable of responding swiftly with meaningful support for both financial markets and depositors.
It is no secret that the frantic pace of interest rate increases contributed to the bank failures and have significantly impacted other areas of the economy, not the least of which is mortgage demand and commercial real estate. What remains to be seen is the path of rates moving forward. Markets are currently pricing in just one more rate hike in May, followed by sequential rate decreases commencing in September. This currently seems like wishful thinking, as inflation is still nowhere near The Fed’s stated target of 2%. As such, it seems premature to suggest any significant interest rate cuts from The Fed.
What didn’t change this quarter? The fact that prediction remains pointless, be it around interest rates, economic growth, or stock market returns.
What else didn’t change? The importance of diversification:
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