Monthly Market Update - April 2023

March Highlights:

• S&P 500 advanced 7.5%, but not a broad-based rally. Top ten gainers contributed 88 percent of the return of the 503 companies in the index, while 220 companies declined during the quarter.
• Intermediate and long-term bond yields continued to fall in Q1 after peaking in early November.

• First significant economic impact of last year’s rapid rise in interest rates exhibited itself in the form of the two largest bank failures since 2008.

In March, two forces converged to shift the primary focus of the market. The lag effect of Federal Reserve rate hikes merged with the law of unintended consequences to create a new form of banking crisis. It began with the March 10 federal takeover of the Silicon Valley Bank, a favorite of venture capital and emerging technology companies -- the second largest bank failure in U.S. history. Soon two other sizable “regional” banks were in trouble. In short, the rate increases undermined the value of Treasuries and other bond investments of the banks. When large customers began withdrawing deposits, these banks were forced to initiate selling their bonds at a loss. Government intervention backing the troubled banks’ holdings has so far contained the damage.

The ensuing flight to safety drove down Treasury yields, producing solid returns for bond investors. The yield on the 2-year Treasury hit a fifteen-year high of 5% on March 8 but immediately retreated to 4% by the end of the quarter, while the 10-year retreated to 3.5% after reaching its fifteen-year high of 4.3% in October. The decline in yields caused the U.S. Aggregate Bond Index to advance 3% for the quarter. Major stock indices showed solid quarterly returns, with the S&P 500 Index advancing 7.5% behind a strong January and a late-March rally. But the rally was not broad-based: eighty-eight percent of the return was concentrated in ten companies, predominantly mega-cap tech companies that have become a new safe-haven for investors during times of crisis due to their fortress balance sheets.

Inflation, the driving force behind Fed rate hikes, edged downward during the quarter but remained stubborn. Employment remained strong. Despite the banking issues, the Fed raised interest rates by another quarter percent in March. But many saw the banking woes as doing the Fed’s work, particularly in the form of tightening credit as banks will need to pull back on lending to preserve liquidity and fund fleeing deposits.

Looking ahead, domestic and European companies are likely to face margin compression this year due to slowing sales volumes and the inability to continue passing along price increases to consumers. One economic bright spot remains China, the re-opening of its economy and the tacit acknowledgment that it needs its technology companies to grow the economy.

To put the first quarter in perspective, a year ago, the federal funds rate was still resting close to zero in the 0.25% to 0.50% range. Now we are at 4.75% to 5%, higher than current core personal consumption expenditures (PCE) inflation. Traditional economic thought is that rate increases take six to twelve months to impact the economy. March’s banking woes are one lag effect so far. The remainder of the year may continue to see volatility due to other unforeseen impacts of Fed tightening.

With interest rates continuing to rise, and the recent trouble in the banking sector, Head of Mid and Large Cap Equity, Haruki Toyama, sheds light on how these factors have impacted the markets, and where opportunities may present themselves moving forward.