Musings on investments Q1 2023
This year markets started on a positive note with substantial gains in stocks but ebbed a bit in March with concerns about the banking sector. March however, as the saying goes, came in like a lion and out like a lamb as concerns eased about the banking situation.
While the bank failures at Silicon Valley Bank (SVB) and others were not, in hindsight, unusual, the suddenness in the development of the situation made folks a bit nervous and wondering if there were more surprises in store.
This latest set of bank challenges came about as a result of higher interest rates pushing down the value of the sorts of high-quality assets banks own combined with a high percentage of the bank’s depositors who were corporate bank clients with large (and therefore mostly uninsured by FDIC) deposits. As those depositors began to withdraw funds the banks were forced to begin to liquidate those securities, and this created anxiety and further bank withdrawals. It didn’t take long for a situation to develop where the banks were thought to be close to being unable to meet their capital requirements and thus regulators stepped in to prevent further damage.
It is important to note that while these sorts of events are unsettling, we have a robust set of protections for banking customers and that those protections were temporarily enhanced in this latest situation to help maintain the well-deserved confidence in our banking system that we have enjoyed for many years.
While returns have eased back from their February highs most market sectors finished the quarter with positive returns. In equites some of the hardest hit areas of 2022 showed the biggest gains YTD with technology issues leading the pack. In the bond markets returns were generally positive as interest rates eased from their highs on expectations of weaker economic growth caused by the Fed’s continued rate increases.
On the valuation front stocks are by no means cheap when considered in the context of forward earnings but are less expensive than they had been at the beginning of last year. Bonds on the other hand, at the level of current interest rates, provide quite attractive dividend yields and thus quite reasonable valuations, especially when considered in the context of the potential for weaker economic growth going forward. Diversified portfolios then, those with exposure to stock, bond and alternative asset classes are in a much better position than they were early last year as the potential for capital appreciation in bonds combined with their higher yields provides much more of a traditional offset to potential equity volatility than they have done in many years.
From an economic perspective our economy continues to grow, even with substantially higher interest rates than we have seen in quite some time. The hope and expectation that higher rates will slow down the economy and thus the pace of inflation got a bit of a boost with the banking concerns of late as banks reassess their loan portfolios and curtail lending to some degree. There is some expectation then that the banking concerns will help the Fed in their quest to slow the economy and reduce inflation and that perhaps we are close to the end of the current rate increase cycle we have been in since the beginning of last year.
While the odds of a recessionary period later in the year are not insubstantial the persistent growth we’ve seen in the face of the rate increases over this last period hold out some hope of a “soft landing” in the economy, a scenario whereby inflation is slowly brought under control without tipping the economy into a contractionary time. With the various capital markets looking 6 to 12 months out and trying to anticipate future conditions some amount of recessionary expectations may already be built into current equity and fixed income prices. There seems to be agreement that an “earnings recession”, a period of soft earnings in corporate America, is likely to occur as the year progresses. Of course, more extreme conditions, those outside a current consensus, are certainly not built into current market valuations and only time will tell just which version of the future comes to pass.
One economic indicator worth paying attention to is consumer confidence. While off its year end low it is still significantly below its average. Often low consumer confidence numbers precede substantial market rebounds, one of the reasons it isn’t a good idea to sell investments when people feel bad about investment and economic prospects.
These last several years have been full of surprises and, while hindsight is always 20/20, a look back over this period seems to reinforce the utter unpredictability of the economy and markets over the short-term. History does show however that portfolio diversification helps to reduce volatility and provide benefits to investors who can stay invested over the medium- and longer-term market cycles, allowing them to benefit from the growth and creativity inherent in our free society and economic system.
We continue to take a disciplined approach to portfolio management, paying particular attention to overall diversification, valuation changes within asset classes and security selection for implementation. Periods of volatility can create opportunities as the markets in particular asset classes overshoot on both the upside and the down. While we cannot predict what the markets will do, we can certainly be cognizant of valuations, and we try to make good decisions both when particular asset classes look too expensive as well as when they go on sale.
This market commentary is provided for information purposes only and is not a complete description or analysis of the securities, markets or developments referred to in this material. There is no guarantee that these statements, opinions or forecasts provided will prove to be correct. All expressions of opinion are subject to change. Information has been obtained from sources believed to be reliable, but its accuracy and completeness are not guaranteed. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Past performance does not guarantee future results.
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