In 2023 US stocks are up 7.1%, international stocks are up 8.6%, and bonds are up 2.9% (1). While markets grinded higher, there were plenty of headlines for investors to consider in the first quarter of 2023. The collapse of three banks, ongoing Federal Reserve policy debate, and a China-Russia summit all combined to whipsaw markets.
Tightening monetary policy rippled through the banking sector in the first quarter, as the US Federal Reserve continued their steepest rate hiking cycle in history. The Federal Reserve’s policies are said to work with long and variable lags, and after a year of interest rate hikes, we finally saw the consequences through the failure of Silicon Valley Bank, Signature Bank, and Credit Suisse. In 2022 as interest rates rose sharply, bond prices fell dramatically, and these banks suffered losses on their bond investments. Then, as customers withdrew deposits from these banks out of fear for the perceived safety of their money, the banks were forced to sell bonds at massive losses. The bonds held on the bank’s balance sheets were US treasuries, so while there was very little default risk, the banks could not wait until maturity.
While specific missteps at Silicon Valley Bank, Signature Bank, and Credit Suisse contributed to their failures, it was ultimately restrictive monetary policy that sealed their fate. Markets swung dramatically in the first three months of 2023 as investors tried to anticipate future Federal Reserve policy decisions. Rates moved lower to start the year, as encouraging data led investors to believe that inflation was on a downward trend. However, rates reaccelerated in February as core components of the Consumer Price Index showed it may take some time to achieve the Fed’s 2% inflation target. In his March 7th testimony to Congress, Chairman Jerome Powell reiterated both his concern over stubbornly high inflation and the Fed's intent to push rates higher than previously anticipated. In reaction to Powell’s testimony, interest rates continued higher. Just days after Powell’s testimony, Silicon Valley Bank's troubles surfaced, and the Federal government rushed in to "ring fence" the banking sector and reassure depositors.
The war in Ukraine continued in Q1 with increasingly significant geopolitical implications. Despite Russia’s latest attempts, Ukraine successfully defended eastern strongholds in Bakhmut and Avdiivka (2) , dealing yet another setback to Vladimir Putin. Much attention was given to the March summit between Putin and Chinese President Xi Jinping. However, despite its appearance there were no major announcements following their meeting. President Xi did not pledge arms to Russia and no deal was made on a pipeline to export Russian gas to China (2). China has tried to cast itself as a peacekeeper during the war as they look to grow their global trade presence.
JFG Outlook
Recent data, such as an inverted yield curve and the leading economic indicators index, support our view that tighter credit conditions will contribute to a slowdown in the economy as markets continue adjusting to normalized growth expectations. The monetary and fiscal policies that were implemented during the COVID-19 pandemic, which led to hypergrowth and excessive risk taking by investors, are a thing of the past. Cashflow is once again important for businesses as capital markets dry up.
Our Q3 2022 market commentary, “Bonds are Back”, was published within days of what could end up being the bottom of the drawdown in bond prices. In late summer of 2022, we made the case for adding duration back to investors’ bond allocations as bond yields were at their highest levels in 10 years and inflation showed signs of peaking. We continue to like bonds as the Fed nears the end of its rate hiking cycle, which crushed bond markets in 2022. A slowing economy and the possibility of a recession should favor high quality investment grade corporate bonds and US Treasury securities, as longer maturity bonds have greater upside when interest rates fall, and higher coupons are scarce. While we have kept the duration of bond holdings short over the past year and a half, we proactively lengthened that duration last year to lock in what we felt were rates that were compensatory for future rate hike risks.
Turning to equities, the S&P 500 index has hovered above and below 4,000 since May of 2022. In our Q4 2022 commentary, “In the Rear View”, we felt there were near term risks to investing in stocks at high valuations and favored a defensive tilt by investing in sectors with a low correlation to the economy such as consumer staples, healthcare, and defense. In our view, the near-term outlook remains cloudy at best, but with the benefit of hindsight we know that making money in stocks over the long term means investing when it feels the hardest to do so. Despite the murky outlook, near-term volatility brings opportunities for long-term investors to buy well run companies at discounted prices.
In summary, investors with liquidity needs can find attractive short-term opportunities in the bond market, while those with a longer time horizon can start investing for the next cycle and future growth. Federal Reserve policy created significant volatility in both the stock and bond markets, and it is best to be cautious when making portfolio allocation decisions. A well thought out financial plan can provide investors with the clarity and confidence needed to stick to a long-term strategy.
Thank you for your continued trust in Juno Financial Group.
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