2023 Q1 Market Notes
2023 started off on a positive foot fuelled by hopes of a Fed pause on interest rate hikes. This proved short-lived. The first spoiler came with hotter-than-expected inflation data and was followed by signs that interest rate hikes are having an economic impact as cracks in the banking system emerged.
The collapse of Silicon Valley Bank in mid-March highlights the dangers caused by rapid monetary tightening. SVB’s main problem was its large holding of long-duration bonds, which lost value as bond yields rose through 2022. (It's probably important to note that this episode bears little resemblance to bank failures in 2008 which were mostly due to losses on mortgage-backed securities.) The sudden and unexpected bank crisis took the S&P 500 on a volatile ride last month, shifting the outlook for interest rates along the way.
The counterforces of high inflation data and the threat of financial sector instability leaves the Fed with difficult choices. High inflation means more rate hikes are warranted, but worries about financial stability argue for moving cautiously. Thankfully, coordinated efforts by regulators and the big banks to backstop the banking industry calmed markets. Investors seem more optimistic that the worst of the mini-crisis is over. It is expected that the Fed will undertake at least one more 25-basis-point rate hike before pushing the brakes. A mild recession, however, is not off the cards.
Having said that, the U.S. stock market remains resilient. Technology has bounced back more than the broader market. The Nasdaq 100 is up over 20% year-to-date. It surged into a new bull market for the first time in nearly three years as traders pile into technology stocks and angst around the recent bank turbulence eases.
The S&P 500 didn’t drop below its December low in the first quarter, an indicator that has historically been a bullish sign for the rest of the year. Since 1950, during years in which the index’s first-quarter low was above its December low, the S&P 500 has averaged a full-year gain of 18.6%. Reassuring, but by no means an inevitable pattern.
Across the pond, it was Credit Suisse's turn to collapse (this was a matter of when, not if) after years and years of scandal after scandal which has no doubt shaken Switzerland's reputation for banking stability. UBS bought its rival for 3 billion CHF in an attempt to avoid devastation in the global banking system.
Nevertheless, European stocks have held up pretty well. Eurozone stocks, as measured by the STOXX Europe 600, posted gains of over 6% over the quarter, with German and French markets leading the way.
European growth has surprised positively. The energy shock from the war in Ukraine was supposed to send Europe into recession over the winter, but growth has remained positive. The unusually warm winter has boosted economic data. Consumers are benefiting from falling energy prices, job gains and improving real incomes. Economic resilience is Europe has been a tailwind for the UK which missed a technical recession and there are signs that the economy is beginning to cool.
March saw President Xi sweep into an unprecedented third term as China’s president, cementing his dominance as he readies China for an era of superpower rivalry and seeks to revive a battered economy.
Fortunately, the Chinese economy is reopening. Chinese stocks are recovering, with the Shanghai Index up over 5% in the first quarter. The government announced a (GDP) growth target of around 5%, which will be reliant on the consumer, given the slowing global economy and the government’s preference to not let property construction aggressively expand. So, the pace of demand recovery in China will continue to be a critical driver for markets.
During the Covid years (2020-2022), an uncertain economic outlook, battered confidence, and rolling lockdowns led Chinese consumers to spend less. Saving rates were on average 4% higher than they were from 2013-2019 (but still notably lower than developed economies).
The rapid reopening policy in China allowed consumption and mobility to quickly normalise in the first few weeks of the year. The potential scale of this consumer-driven rebound may hinge on how willing households are to draw down their excess savings.
I wouldn't underestimate the Chinese consumer, but fully unleashing pent-up demand may be a slow process considering many consumers may remain cautious with the memory of covid lockdowns still fresh. The shape of the housing recovery, a key driver to consumption, is also still very uncertain.
We cannot disregard geopolitical tensions, which remain elevated. The most notable development (other than a supposed spy balloon floating around U.S. airspace) is the U.S. government’s ban on exporting high-end semiconductor chips which are important for some of the strategic goals for the Chinese economy.
Growth has been resilient, but inflation is receding only slowly, and central banks have not finished tightening. Macro factors certainly continue to drive sentiment, but equities' enduring role in a well balanced portfolio should grab the reigns once greater clarity emerges around inflation and the economy. Until that point, it would be prudent to remain selective, or otherwise (as always) keep the long term goal in mind. Diversification of investments and monitoring of developments will continue to be important.