Market Commentary: Q1 2023

At a Glance

• Stocks and bonds rose solidly in the first quarter of 2023, led by a 20% gain for tech stocks
• The Fed raised short term interest rates, but longer dated rates fell in March
• Concerns about the health of the banking sector appear to be contained
• Economic activity remains solid, but the past year’s tight monetary policy may soon bite

A Hot Start

Despite several high profile bank failures in March and worries about tightening credit availability, stock and bond markets closed out the first quarter on a high note. Investors remained confident that easing inflation combined with the challenges in the banking sector will lead the Fed to be less aggressive with rate hikes for the rest of the year. At its March 22nd meeting, the Fed increased the target Fed Funds rate to 5% from 4.75%, matching the 25 basis point increase in February, but also reaffirmed its commitment to reducing inflation to 2%.¹ The debate now is whether the rate hikes implemented so far during this tightening cycle are enough to achieve that goal. February’s core inflation rate did ease slightly (the core Personal Consumption Expenditure index was up 0.3% from January after rising 0.6% the prior month) but still remains well above the Fed’s 2% target.²

Equity Returns: March 2023 and Q1 2023

Stocks posted solid returns for the quarter, led by a 17.05% rise for the NASDAQ composite index. The broader S&P 500 index was up 7.50% while the Dow, last year’s market leader, continued to lag, rising just 0.93% for the quarter.⁶ Small Cap stocks faltered in March, reflecting concerns about a weakening economy and higher exposure to the challenged regional banking sector.⁷ These index trends were reflected in industry returns. The technology and communications services sectors both rose over 20% for the quarter while defensive sectors (staples, utilities, healthcare) and energy stocks posted negative returns.⁸ The financial sector fell sharply in March after the troubles at Silicon Valley Bank emerged. Smaller banks were especially hard hit with the S&P Regional Bank index down almost 30% for the month.⁹ International markets also rose for the quarter with many European indices up double digits in dollar terms.¹⁰ 

S&P 500 Economic Sector Returns: March 2023 and Q1 2023

Fixed income markets rallied in March across all segments except preferred stocks as interest rates fell across maturities. The 2-year treasury yield fell almost 1% during the month and the 20-year yield declined 36 basis points.¹¹ Despite their weakness in March, preferred stocks posted the highest returns for the quarter among fixed income categories, up just over 4%.¹² Corporate bonds, both in the US and Internationally, also fared well, rising over 3%.¹³ While the strong returns for both stocks and bonds this quarter shows a continuation of the positive correlation that presented a challenge to standard asset allocation in 2022, there is some evidence that could be poised to change. In a recent research report, AQR found that, “historically, equity and bond markets have exhibited opposite-sign sensitivities to growth news and same-sign sensitivities to inflation news.”¹⁴ If that historical pattern holds, the current increase in recession concerns and the reduction in inflation worries could be accompanied by a return to negative correlation between equities and bonds.

Fixed Income Returns: March 2023 and Q1 2023

Overshooting? 

Underpinning the strong market returns in the first quarter seems to be a belief that the Fed is close to the end of its tightening cycle and that, if economic conditions weaken, interest rate cuts could be on the table this year. While that path for interest rates may indeed play out, we have not yet seen the kind of economic weakness that typically follows the substantial monetary tightening during the past year (rise in interest rates, removal of quantitative easing measures and the drop in the money supply).  By many measures, economic activity has remained remarkably strong (income and consumption increasing, employment and wage growth strong), but the impact from the past year of Fed tightening may just now be starting to show itself.^15 16 In fact, the Fed itself is projecting just a 0.4% growth in GDP for 2023, implying negative growth for the rest of the year.¹⁷

How much of an economic slowdown is priced into current asset prices is always challenging to know. Still, it is hard to see further multiple expansion if the economy and corporate earnings are poised to weaken. Investors will learn more as the mix of inflation and economic data and Fed policy plays out, but it seems warranted to remain relatively defensively positioned headed into the second quarter. 

¹ https://www.federalreserve.gov/newsevents/pressreleases/monetary20230322a.htm 

² https://www.bea.gov/news/2023/personal-income-and-outlays-february-2023 

³ https://www.spglobal.com/spdji/en/index-family/equity/ 

⁴ https://www.nasdaq.com/market-activity/index/comp/historical  

⁵ https://www.nasdaq.com/market-activity/index/comp/historical  

⁶ https://www.spglobal.com/spdji/en/index-family/equity/  

⁷ https://www.spglobal.com/spdji/en/index-family/equity/ 

⁸ https://www.spglobal.com/spdji/en/index-family/equity/us-equity/sp-sectors/#indices 

⁹ https://www.spglobal.com/spdji/en/indices/equity/sp-regional-banks-select-industry-index/#overview 

¹⁰ https://www.msci.com/end-of-day-data-search 

¹¹ https://www.federalreserve.gov/releases/h15/ 

¹² https://www.spglobal.com/spdji/en/indices/fixed-income/sp-us-preferred-stock-index/#overview 

¹³ https://www.spglobal.com/spdji/en/index-family/fixed-income/ 

¹⁴ https://www.aqr.com/Insights/Research/Journal-Article/A-Changing-Stock-Bond-Correlation 

¹⁵ https://www.bea.gov/news/2023/personal-income-and-outlays-february-2023 

¹⁶ https://www.bls.gov/news.release/empsit.nr0.htm 

¹⁷ https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20230322.pdf 

The views expressed in this material are the views of Atomi Financial Group, Inc. dba Alternativ Wealth through the period ended April 3, 2023 and are subject to change based on market and other conditions.

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