The first quarter of 2023 faced a rapidly changing economic and political landscape. Following 2022, which was an unusual year when both equity and fixed income investments declined by double digits, there was a clear hope for some break from the negative news cycle. In January, the S&P 500 and NASDAQ indexes rallied by 6% and 10.5% respectively. January’s positive momentum carried over into February, however, strong economic data diminished investors’ hopes of a pause in rate hikes. That, in turn, dragged stocks lower and the quarter-end proved to be the most dramatic with the largest bank failure since the 2007-2008 financial crisis and a rebound of inflation fears. Yet, despite all the twists and turns, stocks ended the first three months of 2023 with moderate gains. Large capitalization equities, as measured by the S&P 500, had a rollercoaster quarter but stabilized as bank failure concerns softened, and strength in the technology sector kept the index positive. Small caps underperformed as investors sought the security of large cap companies after increased levels of volatility. Seven of the eleven sectors of S&P 500 were positive this quarter, with technology and communication services posting their strongest quarter since 2010. The more defensive sectors – consumer staples, utilities, and health care – were either flat or slightly negative. Financials were the worst performers.
International equities saw an increase for the second consecutive quarter, with developed markets outperforming emerging ones. Banking weakness also spread to Europe as UBS absorbed the Swiss bank Credit Suisse.
The fixed income market, as measured by the Bloomberg Aggregate Bond Index, gained 4% for the quarter. The yield on the 10-year Treasury note dropped to 3.5% by the end of March, down 0.4% from the end of December. The yield curve was up in the short-term but fell across the remainder of the curve.
Our domestic economy grew at an annualized rate of 2.6% in the final quarter of 2022, slightly less than initial estimates. After a slow start, consumer and government spending provided a boost to the second half of the year. Real-time GDP tracking in the first quarter of 2023 indicates strong growth at a rate of 2.5% annualized. Despite current momentum, however, market participants reasonably expect some slowdown as higher interest rates, tightening credit conditions and higher consumer debt levels slow activity.
The unemployment rate was little changed through the quarter following its 60+ year low reading in January. Meanwhile, the labor force participation rate increased for the third consecutive month in March. U.S. payroll employment surged in the first two months of 2023 with notable job gains occurring in leisure and hospitality, retail, government, and health care.
Housing data was positive across the board. After slowing in recent months, existing home sales jumped in February, snapping a 12-month slide, and representing the largest monthly percentage increase since July 2020. Home prices grew at the slowest pace since November 2019 due to rising mortgage rates.
Consumer confidence surprised to the upside, and the “expectation index”, an outlook for the future, improved.
The annual inflation rate in the U.S. slowed to 5%, rising only 0.1% in March of 2023, which is its lowest reading since September of 2021. While inflation is still higher than the Fed’s target, it is rising at a much slower pace than a year ago.
The Federal Open Market Committee met twice during the quarter and increased the overnight rate by 0.25% in both January and March. The Fed signaled they are moving closer to the end of the hiking cycle but still feel additional tightening may be necessary. We have seen the most aggressive tightening by the U.S. Federal Reserve since the early 1980s, yet the number of new jobs added has averaged 407,000 over the first two months of this year and consumer spending is growing. While it looks like the Fed did turn the tide in its war on inflation, it is too early to declare victory.
Every cycle is different, but this one stands out because of the pandemic, which disrupted supply chains and pulled forward goods demand during the lockdowns. Labor markets tightened quickly due to worker shortages caused by early retirement, increased long-term illness and lower immigration. Large government support packages meant U.S. consumers were sitting on more than $2 trillion of additional savings when lockdowns were eased in late 2021. Add the energy shock from the Russia/Ukraine war and the result is an inflation spike that has been larger and more persistent than most forecasters anticipated.
The first quarter of 2023 had good economic and market results. Even after accounting for the fact that monetary policy acts with a lag from when the Fed first begins to raise interest rates, the U.S. economy has been more resilient than anyone expected. The rest of the year will likely be more challenging as tight monetary policy will take its toll and result in stagnant economic growth in the second and third quarters. Nonetheless, the prospects for the rest of the year continue to look positive, as markets have already priced in a possible soft landing or even a mild recession. While we do have some headwinds, the current economic slowdown and adjustment in interest rates should put the economy and the markets in a better place.
Dumont & Blake Investment Advisors, LLC
March 31, 2023