Week ended March 31, 2023
Off we go (again)
OVERVIEW OF WEEK
The banking crisis seems to have faded for the time being, although to conclude that the repercussions of this unexpected chain of events will not affect the US economy would be silly.
On one hand, the fact that this “mini” bank crisis came and went without more widespread collateral damage is a confidence-booster for investors because it has proven that the US banking system is in good shape, and that the failures of SVB and Signature Bank were in fact isolated.
On the other hand, the failure of these two banks will likely cause lending standards for banks to tighten, meaning that banks will lend less to consumers and businesses, effectively applying brakes on the economy. The silver lining is that such a bank-fuelled slowdown will certainly help the Fed in its fight to tame inflation.
CPI data mid-month, along with yesterday’s PCE data (here), showed that inflation is heading in the right direction (down) albeit falling more slowly than the Fed would like. Over and over again, various Fed officials one after another, express the central bank’s singular commitment to maintain tight monetary policy until it believes it has the 2% inflation target in its sites. US unemployment remains need record-low levels, suggesting that – at least so far – the cost of tighter monetary policy in terms of jobs growth has not been significant (or even present).
Inflation is also declining in the Eurozone albeit recent flash March inflation figures were perhaps slightly higher than had been anticipated (see here). Even though the UK is bucking the trend as CPI moved higher in February (see here, data released Mar 22), there are signs that the UK economy might somehow avoid a recession, an outcome that was widely expected – even by the Bank of England – only several months ago.
US Treasury yields rose sharply this week, perhaps more of a reflection of the unwind of a flight-to-quality during the bank crisis than expectations of higher yields ahead. Still, yields remain well below their end-of-year (2022) levels across the curve, suggesting that:
Central banks might stop their tightening sooner than had been anticipated before the bank problems of mid-March (influences short end of curve),
Slower economic growth ahead is increasingly likely (influences intermediate/long end of curve)
Having said this, I can understand why the recession scenario is not resonating with equity investors. A pending recession has been discussed and predicted for months now but the economy keeps chugging along. To a certain extent, risk markets are treating recession fearmongering like “the boy who cried wolf” – they have heard it enough that they will ignore it until they see it. Perhaps it is this complacency that makes me uneasy. Are risk markets performing better than they should given the context? It’s impossible to say, but to add to my anxiety, I get very uneasy when I see the VIX fall below 20 (Friday close 18.7).
(If you play charts (not my forté), this 2-year chart would seem to scream out “buy VIX now”!)
For the right or wrong reasons, a “no recession scenario” would certainly redeem the Fed. My view, as I expressed in my 2023 outlook in early January in EMC (here), has not changed. I still expect a shallow recession in 2H23 and have positioned my portfolio accordingly. Recall that I play from the “long equity” perspective in good times and bad, so my expectations for this year have principally involved a modest shift into sectors that I think will perform relatively better in an economic slowdown, alongside a reallocation into cash / short-dated USTs and now CDs with yields in the high 4s/low 5s.
Looking ahead as the quarter draws to a close, we will have 1Q23 earnings starting with the large US banks on April 14th, the all-important US employment situation data (i.e. unemployment) for March released April 7th, and the US CPI read for March released on April 12th. The next round of central bank meetings in the Eurozone, the UK and the US does not occur until early May.
Risk assets barrelled ahead this week, with all of the international and US equity indices EMC tracks ending the week higher. European equities delivered the best return WoW, with equity markets in the US, Japan (best YtD), the U.K. and Europe all serving up 2%+ gains.
The DJIA (large cap, concentrated) lagged the returns on the S&P 500 and NASDAQ Composite this week, although all US indices were sharply positive WoW. The tech-heavy NASDAQ Composite index (+16.8% YtD) has outperformed the S&P 500 by more than two times YtD.
UST yields rose across the board this week as inflation data came back into focus. This also reflects the unwind of the “flight-to-quality” bid that occurred post-bank crisis. Even so, total returns were positive in March for USTs, and YtD return of the 20 year+ UST bond index (+7.1%) is in fact marginally better than the return of the S&P 500 (+7.0%).
Corporate credit recovered too as market risk diminished, with spreads tightening across the ratings spectrum but most significantly in non-investment grade. Credit is the first place to look for a risk unwind and has recovered quickly since mid-March. Spreads at the riskier end of high yield are in fact now slightly tighter than they were at year end 2022.
The star of the quarter has undoubtedly been Bitcoin, with the benchmark crypto currency up an unbelievable 72% YtD. There are all sorts of reason for cryptos to have weakened over the last nine or so months, but the fact remains that BTC has demonstrated amazing resiliency even with bombs going off all around it. Well done to crypto investors.
Back in the real world, gold continues to flirt with $2,000/oz, up an admirable 8.2% YtD. The USD seems stable in the 1.02 to 1.03 range for now (vs USDX). WTI crude was up sharply this week (+9.3%) but remains down YtD as investors continue to size up the risk of demand destruction from a future recession.
In summary, the week was solid for stocks and bonds, ending a positive first quarter to the year. This was much needed following disappointing returns in 2022 in most traditional asset classes. I don’t feel entirely comfortable to be honest, but these feelings come and go as markets rise into uncertainty. This is where the mantra on the cover comes into play: “you gotta be in it to win it”!
Corporate bonds (credit)
Safe haven and other assets