BY: JIM PICERNO
DIRECTOR OF ANALYTICS, THE MILWAUKEE COMPANY
Stock markets in the U.S. and around the world rebounded in the first quarter of 2023. After suffering steep losses last year, investors snapped up beaten-down shares. Shares in developed markets ex-U.S. led the way, based on a set of ETF proxies. Vanguard FTSE Developed Markets surged 8.0% in the first three months of the year, closed followed by U.S. shares (VTI), which posted a 7.2% rally. Emerging markets (VWO), by contrast, were far behind with a relatively modest 3.7% gain in Q1.
The recovery in equities is encouraging, but debate still rages about whether the bounce is an all-clear sign vs. a short rally in an ongoing bear market.
U.S. bonds also rose in the first quarter following a rough 2022. The fuel for the gain in fixed income was a combination of headwinds for the economy (which implies lower yields and therefore higher bond prices); elevated geopolitical risk vis-à-vis Russia and China; and expectations that the Federal Reserve is close to pausing, and perhaps reversing, its year-long run of interest rate hikes.
A banking crisis that emerged in March, triggered by the collapse of Silicon Valley Bank, also buoyed bonds, and threatened to derail the first-quarter’s recovery for stocks. But government intervention has, so far, kept a lid on wider contagion. Ground-zero for the crisis: regional bank stocks. After a sharp loss in the first week of March, prices have stabilized for these banks, providing cover for a degree of cautious optimism on the broader market outlook.
If the banking tumult turns out to be a one-off event, markets will increasingly focus on the risk factors that animated much of 2022’s trading: inflation, the war in Ukraine, elevated U.S.-China tension and on-again-off-again headwinds for economic growth.
Andy Willms discusses the concerns swirling around the banking sector in his article for this newsletter, which you can find here.
The main loser in the first three months of the year: commodities. After a strong run in 2022, commodities as an asset class stumbled in this year’s opening quarter.
The strange world of macro and markets that’s prevailed since the pandemic roiled the world continues to play havoc on the art and science of evaluating the outlook. The good news is that last year’s crushing slide in stocks and bonds has faded. That’s a sign that the crowd is becoming more comfortable with the known risks for 2023.
At the start of Q2, the U.S. economy continues to defy the pessimists. Although growth looks set to slow, the consensus view is that output will stay positive and so the odds of a recession for the immediate future remain low.
The Atlanta Fed’s nowcast for the initial estimate of U.S. GDP in Q1 (scheduled for release on April 27) is a moderate 1.7%. A number of economists think even stronger results are possible, although a downshift in some degree looks likely from Q4’s 2.6% increase (seasonally adjusted annual rate).
Another question that hangs over bonds and stocks is whether the relative calm so far this year for the Fed’s inflation-taming plans is a head fake or a sign that the policy tightening over the past year has run its course? The futures market has been going back and forth recently on pricing in odds for another ¼-point increase in the central bank’s target rate at the next policy meeting on March 3. As of this writing, there’s a slight edge in favor of lifting rates again, but it’s best to view this as a coin flip.
The main event is how inflation evolves. The Fed’s preferred measure – based on consumer spending ex-food and energy – is trending lower, but the descent has slowed recently. The 4.6% increase in February vs. the year-ago level is well below the previous 5.4% peak, although that’s still well above the central bank’s 2% inflation target.
It’s reasonable to assume that inflation will continue to trend lower. The sharp decline in money supply – M2 fell 3.1% in March on a year-over-year basis – suggests as much. Nonetheless, a stress test awaits in Q2. If markets can hold on to recent gains, the odds for a rally in the second half of the year will grow.