The first quarter of 2023 saw a continuation of the stock market rally off the October 2022 lows, recording an encouraging pattern of higher lows and higher highs along the way. However, that progress was not made without a good measure of drama mid-March, when a series of bank failures made global headlines. The fact that markets were able to take that news in stride despite growing signs of economic slowing was especially remarkable. Indeed, market volatility measures have fallen all the way back to levels not seen since the start of the bear market in January of 2022.

For the quarter, US large-caps stocks rose +7.5% (‘SPY’ ETF Proxy), even as developed nation overseas stocks rose a full +9.0% (‘EFA’). While impressive, more subdued performances in the financial sector-sensitive small-cap, value, high-dividend, and low-volatility factor arenas made for historically divergent performances among indices. A January snapback recovery in the technology sector that was later accelerated by a flight to relative safety away from banks supported an especially concentrated advance. And, although changes in bond yields were extremely volatile, the Bloomberg Aggregate Bond Index also finished higher, up +3.2% (‘AGG’).

Expectations had been for a significant increase in rates by the Federal Reserve on hot jobs reports and persistent core inflation. However, concerns over tightening credit after a string of regional bank failures led the FOMC to only raise rates by +0.25% (BBC, “US raises interest rates despite banking turmoil,” 3/23/23). Fortunately, rapid action by regulators to provide troubled banks with loan facilities stemmed fears of further contagion. Meanwhile, the yield curve continues to invert, suggesting a possible recession ahead despite bubbly equities. The only negative outcome for the quarter was among commodities, which fell -3.7% (‘DBC’), reversing a portion of their prior year gains.

If a recession does occur, the possibility of a soft-landing remains on the table given the rapid decline in inflation and a persistently strong labor market. There has been a prior instance of stocks advancing despite a recession just post-World War II. Though distant in time, there are some corollaries there with an exogenous shock having forced both fiscal stimulus and a coincident bear market followed by a re-balancing period afterwards. Also, stocks have historically advanced an average +19% after a federal funds rates peak, should that occur (WSJ, “Fed Pause Wouldn’t Necessarily Refresh Stock Market” 4/16/23). However, with valuations back on the high-end of normal, an earnings recession almost certain, and a debt ceiling conflict brewing, reasons for caution remain. Until markets can provide a stronger green light on investing, we will continue to weigh all possibilities and adjust portfolios accordingly.

Source: Index proxies based on dividend adjusted ETF time-series data from CSI Data, Inc. Data considered dependable, but not guaranteed. Past performance is no guarantee of future performance or profitability. Statements herein do not constitute individual investment advice.