April 2023: Financial Markets Navigate a Sea of Calm (with Undercurrents)

April brought a sense of relative calm to financial markets, a welcome change after the volatility of previous months. However, beneath the surface lurked currents of uncertainty that could impact the future trajectory. Here’s a snapshot of the key themes:

Market Consolidation:

• Major indices saw modest gains, with the S&P 500 up 1.6%, the Dow Jones rising 2.6%, and the Nasdaq barely inching forward at 0.1%.
• The subdued trading reflected a balance between positive earnings surprises from large tech companies and lingering concerns about global inflation and ongoing geopolitical tensions.

Bond Market Stability:

• Interest rates stabilized, with the 10-year U.S. Treasury note holding steady at around 3.45%.
• This reflected the market’s perception of a measured pace of Federal Reserve rate hikes, despite continued hawkish rhetoric.

Mixed Sector Performance:

• Value stocks outperformed growth, with energy and financials leading the charge.
• Technology lagged behind, despite solid earnings from individual companies.

Global Market Divergence:

• Developed markets performed slightly better than emerging markets, with the MSCI EAFE rising 2.8% compared to the MSCI EM’s 1.1% decline.
• China’s economic slowdown and regional geopolitical anxieties weighed on emerging markets.

Other Notable Events:

• The International Monetary Fund (IMF) downgraded its global growth forecast, citing increased economic risks.
• The Bank of Japan maintained its ultra-loose monetary policy under new Governor Kazuo Ueda, highlighting the divergence in global monetary policy strategies.

Overall, April 2023 was a month of market consolidation marked by cautious optimism. However, the underlying currents of economic uncertainty and potential policy divergences could shape the next phase of the market’s performance. The ability of central banks to navigate the tightrope of inflation control and economic growth will be crucial in determining the future direction of financial markets.

HIGHLIGHTS

• S&P 500 +0.87%
• Despite a rally this year, less than 1/3 of the stocks in the S&P 500 have outperformed the index.
• Apple and Microsoft make up 14% of the S&P 500.
• The S&P trades at 18x next year’s earnings versus a 16.9x five-year average (for the period ending 2019), and interest rates are much higher now.
• The average recession drops EPS by 31%.
• The debt ceiling crisis is still out there and will have to be dealt with soon.

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MARKET RECAP

• S&P 500 -0.1% for the week
• Most of the advance this year is due to the largest 20 stocks in the S&P 500.
• The equity risk premium, currently 1.59%, is the lowest since October of 2007.
• CAPE is at 29, in the 90th percentile.
• OPEC announced a surprise cut in oil production; energy moved up in price.
• US bank lending fell in the last two weeks of March by the most on record.

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MARKET RECAP

A big week for stocks as US markets rallied by 3.64% and international stocks by 3.37%. Bonds were off by 0.52%.

A winning quarter wrapped up on Friday, with US markets up by 7.2% and the Nasdaq up by 17%. Bonds also rallied for the quarter, up by 3.23%, as the 10-year yield fell from 3.826% to 3.491%. The much-feared recession has yet to arrive, and the labor market is still strong. The Fed has continued to raise rates, but that did not stop a winning quarter.  Estimated earnings for the quarter just ended are expected to drop by 4.6%, following a 3.2% decline in Q4. But investors seem to be looking past all of that.

For all the predictions by the “experts” that the market will turn down with all of the bad news, stocks have taken a near-term turn upwards and are back up the declining trend line.

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March 2023: Rebounding Spirits Amidst Banking Jitters

Following February’s pullback, March saw a rebound in sentiment for financial markets, albeit amidst new concerns. Here’s a breakdown of the key highlights:

Equity Market Bounce:

• Major indices recovered, defying some negative forecasts.
• The S&P 500 climbed 4.5%, the Dow Jones 3.4%, and the Nasdaq a staggering 17.05%.
• Growth stocks continued their outperformance, leading the charge in the recovery.

Fading Concerns Over Inflation:

• The CPI fell for the first time since October 2021, fueling hopes for peak inflation.
• This dovish sentiment led to a decline in long-term bond yields.

Central Bank Tightrope Walk:

• The Federal Reserve maintained its 0.25% rate hike pace, while acknowledging the potential for slower economic growth.
• Global central banks like the Bank of England and the European Central Bank also began a gradual process of policy tightening.

Banking Sector Stress:

• The collapse of Silicon Valley Bank, a key financial institution, rattled the banking sector and created short-term volatility.
• However, government interventions and broader market resilience minimized the damage.

International Markets Uptick:

• Developed markets like the MSCI EAFE recovered 4.2%, while emerging markets, particularly China, also bounced back with a 2.3% gain.

Other Notable Events:

• China set a lower GDP growth target of “around 5%” for 2023, indicating concerns about its economic slowdown.
• The ongoing war in Ukraine continued to contribute to supply chain disruptions and energy price volatility.

Overall, March was a month of renewed optimism for financial markets. The fading threat of inflation and cautious central bank actions allowed for a rally, despite the temporary shock of the banking crisis. However, uncertainty remains regarding the sustainability of the uptrend, with factors like geopolitics and potential economic headwinds playing a role.

MARKET RECAP

US stocks managed a gain for the week as the S&P 500 finished up by 1.48%. Bonds also were up as yields fell slightly. The 2-year yield fell five basis points to 3.76%. The peak on the curve is about 4-5 months out at 4.8%.

The scare in banking is hurting financing. No investment-grade credit has been issued since the collapse of Silicon Valley Bank. In the high-yield market, the percentage of distressed issues yielding 10% or more compared to equivalent Treasuries’ increased to 10.6% from 7.8% seven trading days prior. Some economists estimate the hit to the economy would be the equivalent of raising rates by 1/2 point to 1.5 points. Even with that, the Fed went ahead this week and raised rates by 1/4 point.

An aggregate M-Score for almost 2,000 companies shows the probability of fraud in the group is at the highest level in 40 years. The M-Score, developed by Messod Beneish from Indiana University, worked with several co-authors to measure the aggregate score. The M-Score received prominence for spotting problems with Enron three years before its collapse. It measures if companies are getting too aggressive with their accounting and/or committing fraud. The metric often rises rapidly before a recession.

All in all, the probability is increasing that a recession is coming.

One big winner is gold; GLD is up by 9.5% year-to-date.

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MARKET RECAP

In the midst of the continuing bank chaos, gold hit an 11-month high, and bitcoin rose to over $27,000 from about $20,000 last week. The S&P was up 1.4% for the week but down 3.2% over the past two weeks. The Nasdaq is up by 4.4%.

The Feds were active this week in trying to keep bank depositors calm to stem a run on the small banks. Signature Bank was taken over, and 11 major banks deposited $30 billion in First Republic Bank to help keep the bank afloat. A program was put in place to lend money to banks in need. Then the Swiss central bank had to back Credit Suisse Group to the tune of $53 billion. Treasury Secretary Janet Yellen said, “Americans can feel confident that their deposits will be there when they need them.” The overall turmoil increases the odds of a recession.

At least for now, the bank problem is one of liquidity, not solvency.

As quickly as bank stocks were selling off, there was wild demand for Treasuries. Since March 8th, the yield on the 2-year treasury has fallen by 124 basis points from 5.05% to 3.81%. The 10-year has dropped from 3.98% to 3.39%. The three-month t-bill is now at 4.52% from 5.06%. Gold is up 8.4% and oil is down 13.4% in the last eight days.

But the overall market is not in panic mode. The VIX is at 25.5 and junk bonds trade in a normal range.

Commercial real estate might be the next big problem. They make up 24% of all bank loans, and many are at risk of default.

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MARKET RECAP

Stocks took a big hit, falling by 5.06% in the US and 3.44% outside the US. Bonds rallied on lower interest rates. The fall in US markets put equities back below the declining trend line and lower than the 200-day moving average. On Tuesday, Fed Chair Powell’s comments indicated a chance of a 50 basis point increase at the next Fed meeting, a hawkish stance. Then, on Friday, the Silicon Valley Bank (SIVB) failed.

SIVB was taken over by regulators.  The bank had $200 billion in assets and was the second biggest bank failure of all time, trailing Washington Mutual ($300 billion) in 2008. The bank relied on private equity funding as compared to regular deposits while at the same time having a very high level of loans. The vast majority of the assets the funds held were classified as “hold-to-maturity,” which means the bank did not have to mark the bonds to market. Given the dramatic increase in interest rates, the bonds had substantial unrealized losses. It wasn’t that the bonds were not creditworthy, just that the duration mismatch (holding long-term assets while having short-term liabilities) left SIVB susceptible to a bank run, and that is what happened. Even before the “run,” customers pulled money from SIVB to get higher interest rates elsewhere. What happens now remains to be seen. But the first casualty might be the Circle stablecoin, which had $3 billion of its $40 billion in reserves at the bank.

The failure sent yields plunging. The 2-year treasury yield fell by 31 basis points on Friday to 4.59% and 45 basis points over two days.

The February jobs number outpaced estimates. Nonfarm payrolls were up by 311,000 compared to the estimate of 215,000. The rise in average hourly earnings was only 0.2%, less than expected. And there was higher participation. Overall a good report, but the bank failure entirely overshadowed this.

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MARKET RECAP

Stocks moved ahead for the week, in the US at +2.05% and outside the US at +2.79%. The market is still trading at a somewhat high level, given where interest rates are. The 5.3% earnings yield on the S&P 500 is barely above the almost 5% that treasuries yield going out up to 2 years. This is a divergence that, over the long run, likely won’t hold.

The market expects rates to top out at 5.25% to 5.5%, with the next hike to be 25 basis points. But with a hotter-than-expected economy, there is now a push to go for 50 basis points.

The economy, so far, is still advancing. The Atlanta Fed GDPNow shows Q1 GDP at 2%+, and the ISM services index stayed at 55.1, indicating an expanding economy. At the same time, though, the ISM manufacturing index is 47.7, indicating a contracting economy. Global PMI is now north of 50.

Warren Buffet took a direct shot at President Biden when he said in his annual letter, “We you are told that all [share] repurchases are harmful to shareholders or to the country, or particularly beneficial to CEOs, you are listening to an economic illiterate or a sliver-tongued demagogue.”

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