Market Update
(all values as of 03.29.2024)

Stock Indices:

Dow Jones 39,807
S&P 500 5,254
Nasdaq 16,379

Bond Sector Yields:

2 Yr Treasury 4.59%
10 Yr Treasury 4.20%
10 Yr Municipal 2.52%
High Yield 7.44%

YTD Market Returns:

Dow Jones 5.62%
S&P 500 10.16%
Nasdaq 9.11%
MSCI-EAFE 5.06%
MSCI-Europe 4.60%
MSCI-Pacific 5.82%
MSCI-Emg Mkt 1.90%
 
US Agg Bond -0.78%
US Corp Bond -0.40%
US Gov’t Bond -0.72%

Commodity Prices:

Gold 2,254
Silver 25.10
Oil (WTI) 83.12

Currencies:

Dollar / Euro 1.08
Dollar / Pound 1.26
Yen / Dollar 151.35
Canadian /Dollar 0.73

The first quarter of 2023 was eventful, not unlike the past 3 years. The economy continues to grapple with high, but falling, inflation and interest rate hikes from the Federal Reserve. The war in Ukraine continues, although much less talked about by major news outlets. And now, the world’s financial system has taken a hit as several large banks failed over the course of a week in March. While it is impossible to know if these failures will have a ripple effect, it doesn’t appear that this will turn into a 2008 like financial crisis. Inflation is still the major data point driving the markets, and the economy is still experiencing far too much of it. The Fed has continued to hike rates at a record pace with little signs of a pause, however, the banking crisis we saw in March could cause them to flinch if earnings and growth come in softer than expected. It is hard to keep your foot on the gas when it looks like a cliff could be on the horizon.

I can appreciate that this all sounds bad, however, there are still bright spots out there. M2 money supply which exploded in 2020 and 2021, which some would argue was the driver of the inflation problem we are experiencing, has been in consistent decline since last year. Banks hold nearly three trillion dollars in reserves, compared to basically zero prior to the 2008 financial crisis. Unemployment and corporate earnings have been incredibly resilient in the face of inflation. Despite the lack of materially good news, the S&P 500, which was down nearly 25% last October, has returned 15% in the last two quarters.

Another bright spot that was majorly overlooked in 2022 was that even though the market fell around 20% on the year, the income produced by S&P 500 dividends increased by around 11%. This is what companies pay out to their investors for simply holding their stock. I consider it a bonus for not panicking out in any given year. For the last decade investors (especially retirees) have been starved for income with cash and bonds yielding next to nothing, but the stock market’s dividend has continued to grow over that same time.

For pre-retirees, accumulating capital for retirement becomes significantly easier when dividends are increasing. These dividends are reinvested for more shares, and in a year like 2022 these reinvested dollars were buying shares at deep discounts. As equity investors, much of our lifetime investment returns occur during bear markets, unfortunately it can take a while to see these returns.

And of course, for retired investors, in a year where we saw peak inflation come in at over 8%, getting an 11% raise on your income likely far outpaced other cost of living increases seen with pensions or Social Security. In fact, the S&P 500 dividend has outpaced inflation by about three times over the last 50 years. So, while the account statement may be painfully down from time to time, the income generated by stocks was up quite nicely, and income is what pays the bill at the grocery store.

Significant and prolonged declines in stock prices are the norm, but they have always been far outpaced by the subsequent advances. Patient investors will continue to be rewarded in the long term, even with rough patches like we have experienced recently.

 

1st Quarter Review

The S&P 500 ended the first quarter with a modest gain despite more rate hikes by the Fed and the largest bank failures since the 2008 financial crisis. January saw strong gains of more than 6% as inflation indicators continued to decline and the Fed appeared to be nearing the end of its interest rate hiking campaign and investors became optimistic of a “soft landing”. Additionally, earnings were better than expected, indicating corporate America continues to be resilient in the face of inflation and rate hikes.

The bulk of the S&P 500’s quarterly returns would come in January as volatility picked up in February and March. In February, economic data reversed, and the economy experienced significant jobs gains, implying the labor market is still extremely tight (something the Fed believes is contributing to inflation). Additionally, various Fed speakers implied that there may be a need to hike rates further into 2023 than expected towards the end of last year.

Closing out the quarter, the markets were grappling with the idea of even higher interest rates when investor focus shifted to a growing banking crisis, sparked by the sudden failure of Silicon Valley Bank, which at the time was the 16th largest bank in the US. This was followed by the failure of Signature Bank of New York and concerns about a regional banking crisis spiked. The Federal Reserve and Treasury Department stepped in to prevent mass panic and eased concerns about the health of the financial system. While this caused a sharp drop in the market, the S&P 500 quickly recovered as policy makers indicated that they are likely close to the end of the current rate hike campaign.

The markets were resilient in the first quarter as further declines in inflation and quick actions by the government in response to regional bank failures helped bolster confidence in the banking system. Both stocks and bonds experienced solid performance to start the year.

Looking Ahead

Markets enjoyed a solid rally to start the year, however, looking ahead there are still major issues that will determine the path of the market going forward. These issues include 1) the US banking issue (will it deepen?) 2) Will the Fed pause, raise, or cut interest rates? 3) Inflation (will it continue to decline?) 4) Economic growth (are we headed for a painful slowdown?)

The S&P 500 has returned 15% over the last two quarters. For that to continue and a new Bull market to start, a few things need to materialize. First, it needs to be clear there is no systemic banking crisis that extends into the regional banks. So far, this appears to be the case. The collapses seem contained and the markets are happy with the government’s response to intervention. Second, the Fed will need to cut rates this year.  The Silicon Valley Bank collapse could act as an accelerant for the Fed to pivot, and a cut would likely help boost corporate profits and strengthen economic growth. Third, inflation needs to continue to decline. It’s a stretch to say that we will be back at 2% inflation any time soon and the Fed knows this. If inflation continues to decline and we get “close enough”, I would anticipate a Fed pivot. Lastly, if we see a Fed pivot sometime this year and economic growth remains resilient, the Fed can pull off a soft landing (avoiding a major recession). For a Bull market breakout to materialize, a lot of things that must go right in a market that seems to have only had things go wrong in the last few years.

If things get worse and the current Bear market picks up steam, the following scenarios will likely materialize and worsen over the rest of 2023. First, if a banking crisis starts to form it could easily be the trigger for recession. We will likely experience the fallout from SVB in the coming months and time will tell whether the government’s response was enough to prevent further damage in our financial system. Second, if the Fed continues to hike rates and we don’t get a rate cut until 2024 that will strain the economy and corporate profits. Combined with other risks (bank failures, geopolitics, etc.), the economy is in a fragile state, and it needs to see a hint of monetary easing this year.

 
 

Third, if the decline in inflation stalls, that would cause a major dilemma for the Fed. Do they stay the course and continue to tighten until they hit their inflation target, or do they reverse track and switch focus from inflation to growth?  Either path would bring Jerome Powell and the Fed significant criticism. The final Bear market scenario would be a quick deterioration in economic growth. The economy is just starting to feel the impact of the last 12 months of rate hikes and layoffs are starting to occur. If the labor market weakens too quickly and growth halts, that could certainly tip the economy into recession.

This investment climate remains challenging, and we are committed to helping you navigate this difficult environment. Successful long-term investing is a marathon, not a sprint, therefore it is critical to stick to the plan and remain appropriately invested based on your individual circumstances and needs.

Please do not hesitate to contact us with any questions, comments, or to schedule a portfolio review.