First Quarter Review 2023

By White Pine Wealth Management

Executive Summary

• After a tumultuous 2022 saw the S&P 500 index down by nearly -19.5%, and the tech-heavy Nasdaq-100 down -32.6%, the markets rallied to start 2023. The S&P 500 finished the 1^st quarter up +7.5%, according to Hightower’s Stephanie Link. Under the surface, “growth” stocks outperformed “value” stocks during the quarter, with the S&P 500 Growth Index up 9.6% versus +5.2% for the S&P Value. Generally, the stocks that were hit the hardest in 2022 were the best performers during the first three months of 2023, though for many stocks, recent rebounds have generally not been large enough to reclaim the prior year’s losses.
• The most prominent economic news in the 1^st quarter was the failure of Silicon Valley Bank and Signature Bank, and the near failure of others. Fortunately, the bank failures in mid-March did not spark a wider “contagion” of bank runs, as no other financial institutions have failed since the SVB weekend. However, we view the demise of these banks as a symptom of the transition from a near-zero interest rate world to one where interest rates have significance again.
• Bonds found some footing in the first quarter of 2023 after they, too, produced significant losses in 2022, due to sharply rising interest rates. After dropping -13% in 2022, the Bloomberg Aggregate Bond Index rose +2.96% in the 1^st quarter, according to data provided by Black Diamond. Now that the transition of a 0.25% Fed Funds rate to a 5.0% Fed Funds rate is already behind us, coupon interest will likely account for a greater proportion of the total return for bond portfolios than it has for a very long time. This could help to reduce the correlation between bonds and stocks, making bonds a more effective tool for mitigating portfolio volatility than they recently have been. 
• While still higher than the 1980’s, inflation started to decline modestly near the end of 1Q23, after peaking at a rate of more than 9% in June of 2022. According to the U.S. Bureau of Labor Statistics Inflation report, the consumer price index was 5% at the end of March, on a year-over-year basis, down from 6% in February. Though softening inflation is a welcome sign, the mechanisms that were necessary to bring about this reduction will likely present challenges to investors moving forward.

Second Quarter Outlook 2023

We believe that one of the most important disciplines for an investor to practice is to not become so married to one’s opinions that new and contradictory data gets discounted. In other words, it is important to stay flexible and heed a variety of data. That said, the data that has been coming through lately has been frequently contradictory, but taken in aggregate, has left us leaning toward caution, while remaining open to positive developments.

What follows are the main topics we’re focusing on, as well as some of the contradictory data we referred to.

• Inflation, the Fed…: No one wants to see bank failures, but the SVB collapse has largely been viewed as a disinflationary event, aiding the Federal Reserve in its fight against inflation. To wit, some analysts, including Strategas’ Chief Economist Don Rismiller, believe the Fed has already concluded its tightening in this cycle. While it may seem counterintuitive that the Fed might halt their rate increases with the Consumer Price Index still sitting at 5%, it helps to remember that it is not the interest rates themselves that extinguish inflation, but the reduction in economic activity brought about by those rate increases that does the job, and there tends to be a lag between the two.
• …And the economy: A question that is top of mind for many investors and allocators: Will there be a recession and what does that mean for my portfolio? We find ourselves at a point where strong cases can be made for both positive and negative investment environments for the rest of 2023.

With such a wide variety of potential future outcomes, investors will do well to maintain balance in their portfolios and remain receptive to new data as it flows in. Steadfast opinions can be very hazardous in the complex and fluid world of investing. Accordingly, what follows are some data points and historical parallels that, taken together, imply that caution is warranted, but there are some very key pieces of data points that serve to contradict that sentiment that should not be ignored.

• The yield curve remains inverted. This event is perhaps the most famous precursor of recessions.  In fact, in March, the spread between 10-year and 2-year yields reached its deepest inversion since 1981.
• Credit Tightening: In the immediate aftermath of the aforementioned bank failures in mid-March, many investors surmised that credit availability would become depressed. The thinking was that smaller banks, spooked by the failures of Silicon Valley Bank and others, might curtail lending by tightening their lending standards. The NFIB Small business report on April 11^th appears to have confirmed this as it indicated that the availability of loans, compared to 3 months ago, has turned down sharply, data courtesy of NFIB and Strategas.
• The Consumer: Individual consumption continues to be the powerhouse of the U.S. economy. As of 4Q22, consumer spending was by far the largest component of nominal GDP, at 67.9%. Government spending, for context, was the second-largest component, at 17.5%, according to JP Morgan Asset Management. Given its influence, any analysis of the state of the economy must consider the state of the consumer, and data still suggests strength. The unemployment rate as of the end of March stood at 3.5%, which is just slightly higher than the 53-year low of 3.4%, set in January, according to the associated press. No recession has occurred without a rise in unemployment and unemployment remains (for now) at historically low levels.

• Relative leadership in bellwether relationships suggest a slowdown: Chris Veronne of Strategas noted on April 10^th the strength of Discretionary vs. Consumer Staples, Transports vs. Utilities, Small Caps vs. Large Caps, Copper vs. Gold, High Beta vs. Low Beta, are all meaningfully softer today than they were earlier this year.
• 7 of the last 9 Federal Reserve rate-hiking cycles have resulted in a recession, according to Strategas.
• Lastly, on April 12^th, the Conference Board pegged the likelihood of a recession in the next 12 months at 99%.

To conclude, it appears that a recession is likely but might be mitigated by sustained strength in consumer spending.  Stay tuned!