April 4, 2023
2023 First Quarter Update
When we delivered our year-in-review seminars in early January, we characterized our outlook for 2023 as “cautiously pessimistic.” This tongue-in-cheek description encapsulated our view that while unresolved issues were likely to impact the economy and markets in unforeseen ways, history and our capital market assumptions supported an improved forward return outlook.
With the first quarter of 2023 on the books, we have seen examples of such previously unforeseen circumstances which have significantly complicated the environment for policymakers. Fortunately, and while not lacking for volatility, financial markets have thus far proven more resilient than might have been anticipated.
Monetary Policy Complications
Exiting 2022, inflation appeared to be moderating as payroll additions trended lower. Expectations for a terminal Fed Funds rate of approximately 5% to be reached by mid-2023 were holding steady since October. On February 1, following the first FOMC meeting of the year, Chairman Jerome Powell said “We can now say, I think, for the first time that the disinflationary process has started… We can see that.” His comments were accompanied by a quarter point rate increase, which marked deceleration from a 0.50% increase in December and 0.75% increases in each of the prior four meetings.
The landscape shifted rapidly following a blowout January jobs report (+517K payroll adds vs. +225K expected) on February 3 and a hotter-than-expected inflation reading on February 14. Terminal rate expectations raced higher as market participants rapidly updated their outlooks. In congressional testimony delivered March 7, Chair Powell confirmed the shift in outlook suggesting the path of rate increases would likely be steeper and hikes would persist longer than previously thought.
A second strong jobs report released on March 10 was overshadowed by three regional bank failures,which highlighted stress placed on the US financial system by rapid rate increases over the last year. Federal regulators stepped in to backstop deposits and placate concerns over broader risk to the US banking system, but investors marked down expectations for the Fed Funds rate to 4.8% (below February 1 levels and down from a peak of 5.7%) in a matter of days.
While expectations took the scenic route, the March 22 FOMC meeting went largely as had been anticipated following the Fed’s February 1 meeting. Policymakers raised interest rates by 0.25%, bringing the Fed Funds range to 4.75-5.00%. The committee maintained projections for a year-end 2023 top rate of 5.25% – noting that offsetting factors left projections largely unchanged. Chair Powell stated that the US banking system is “sound and resilient” noting that recent developments were likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation. In other words, monetary policy tools might have less work to do.
Part of our “cautious pessimism” entering the year was because investors appeared to have their gloves up, already anticipating negative developments. As a result, investment markets fared better in the first quarter of 2023 despite the unforeseen circumstances.
Global Equities: In 2022, global equities declined 18.4% with domestics (-18.1%), developed international (-14.5%) and emerging markets (-20.1%). Year-to-date in 2023, global equities are up more than 7% with domestics (+7.1%), developed international (+8.5%) and emerging markets (+4.0%). Returns remain negative over the twelve months ended 03/31/2023, but have improved materially compared to the twelve months ended 12/31/2022.
Fixed Income: In 2022, rates were largely on the rise. From a starting yield of 1.51% on the US 10-year treasury, rates peaked at 4.24% in October and closed the year at 3.87%. As a result, bond returns were decidedly negative in 2022. In the first quarter of 2023 rates moved lower, closing the period at 3.47%. As a result, bond markets have rallied year-to-date.
It’s still early and circumstances can change quickly when financial stress is afoot, but amid warnings of a banking crisis, a credit-driven recession, pivoting central banks and stagflation, the best strategy so far for investors has been to maintain discipline.
Recession Likely As Ever
Three months have passed, but remarkably little changed in our recession-predicting calculus in the first quarter. The economy continues to face challenging macroeconomic conditions, several of which have been present in prior recessions, and economists continue to assign a 65% likelihood that the US will enter a recession in the next twelve months. Meanwhile, traditional indicators are sending the same mixed signals we observed at year end with a strong labor market countered by inflation-dampened consumer spending and an inverted yield curve.
While recessions are a relatively common occurrence (we’ve experienced one every 4–5 years since World War II) they’re typically not so widely-predicted as the next one seems to be. We have to consider just how damaging a recession might be if it is well-anticipated. In particular, when global equities are already discounted by nearly 20% and the Fed is able, if not willing, to offer relief by loosening policy from current levels.
Despite an ever-changing landscape, we remind our clients the importance of staying disciplined in the face of uncertainty. In the remaining nine months of 2023, we are likely to see even more examples of the previously unforeseen. That doesn’t mean blindly staying the course. It does mean staying committed to the financial plan you developed with your advisor, avoiding major asset allocation shifts and resisting the temptation to time the market while we do our part to ensure your portfolio is optimally positioned for the long term. On behalf of the entire team, thank you for allowing us to serve on your behalf.