Matching assets with liabilities is one of the prudent rules of banking. The failure to do that led to
such financial crises as the Savings & Loan collapse of the 1980s and it surfaced again when a little-known,
yet financially prominent California bank collapsed last month, sharply shifting economic
fortunes and central bank policy.
Rising interest rates amidst high inflation was the backdrop of much of last year’s investment
story. The Fed raised interest rates seven times in 2022 and twice in the first quarter of 2023. Those
rate hikes increased short-term yields by 4.75 percentage points, a giant move upward. Long-term
rates followed suit, though they didn’t rise quite as much, and the resulting decline in the values
of long-term bonds was breathtaking: down 21% – nearly double the decline of the S&P 500 – since
the beginning of last year.
During the years of near-zero interest rates, many investors bought long Treasury bonds in search
of modestly higher interest rates. Though safe in terms of credit risk, long Treasury bonds were
subject to these dramatic losses as interest rates rose. Suddenly, Silicon Valley Bank (SVB), a buyer
of long-term Treasuries, found itself caught in the vice of sharply falling asset values and the need
to raise funds to meet rapid deposit withdrawals by its predominantly tech startup clients.
The ensuing runs on SVB and then Signature Bank in early March, and their sudden collapses,
soon followed by the near-collapse of global banking giant Credit Suisse, created the imminent risk
of financial contagion that could have quickly taken down the American and even global banking
systems. Prompt action by the FDIC to insure all deposits at the American banks, and the rescue
of Credit Suisse by Union Bank of Switzerland, stemmed the tide. It also quickly replaced the
environment of sharply rising interest rates with a sharp, market-led decline in rates, and a very
moderated response by the Fed to avoid sparking further banking crises.
With that, investment perspectives shifted. Despite an initial sharp selloff in equities, stocks generally staged a rebound following
the onset of the SVB crisis, spurred upward by the decline in interest rates. Though the KBW Bank Index declined nearly 25% from
March 8 through quarter-end, the S&P 500 gained almost 2%, marking a significant shift in investor sentiment. (SVB lost 100% of its
market value.)
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Suddenly, the Fed’s year-long war against inflation was replaced with a delicate balancing act, with rising prices on one side and
financial contagion on the other. Despite the rate hikes, inflation remains a
concern. Recent measures showed prices up 6% year-over-year. Strong job
production and a tight labor market (unemployment is a mere 3.6%!) will keep
the Fed vigilant in its inflation fight. More rate hikes are not off the table.
Meanwhile, the US economy appears to have maintained surprisingly modest
growth during the first quarter, pacing a 2.5% growth rate, despite growing
expectations of an interest-rate-induced slowdown or recession later this
year. The possibility of more restrictive bank lending in the aftermath of the
SVB failure could impose further hardships on the economy going forward.
Despite the quick action by federal policymakers, analysts are
not certain that this most recent banking crisis is yet behind
us. Likewise, the forecast for near-term corporate earnings
continues to be weak, but with brighter prospects in the second
half of this year. It is always important to remember that markets
are forward-looking.
/Education_and_Advice/CNBU_Articles/QP-Chart2-Spring23.png)
Source: FactSet, Goldman Sachs Investment Research; as of 2/16/23
Despite the severity of last year’s equity selloff, particularly
among growth stocks, equity markets may have turned a corner
as long ago as September. With the S&P 500 posting a 7.5%
gain in the fourth quarter, it had momentum coming into the
new year. Optimists might conclude that the Fed’s aggressive
rate hike program was largely in the rearview mirror. If so,
that would provide opportunity for equities to continue their
recovery. Moderation in inflation reports last year supported
that case and equities climbed through early February (up over
9% for the S&P 500) as longer-term interest rates began to drift
lower – responding to, and creating, concerns about a potential
recession via a more inverted yield curve.
However, inflation was not abating as quickly as investors or
the Fed would have liked, and by February, stubbornly high
inflation measures reignited fears of yet more aggressive rate
hikes by the Fed. The collapse of Silicon Valley Bank in early
March brought another big shift in interest rates as described
above. From peak to trough, the yield on five-year Treasuries
dropped 100 basis points during March (despite a smaller 25
basis point rate increase by the Fed late in the month). Although
many regional bank stocks dropped sharply, the large money
center banks (generally considered too big to fail) fared better.
Outside the banking sector, the drop in interest rates sparked
a renewed rally in stocks. By quarter end, the S&P 500 closed
7.5% higher.
Beneath the broad numbers, however, there remained large
disparities. Growth stocks, the bane of equity markets last year,
became the darling of investors in January. Having trailed value
companies by more than 20 percentage points last year, the
Russell 1000 Growth Index far outpaced its value counterpart by
more than 13 percentage points in the first quarter. Moreover,
the Russell 1000 Value Index posted a meager 1% gain for the
period. That pattern was duplicated across the various equity
sectors: solid gains for growth with generally flat returns for
value. Among the broad benchmarks, international modestly
outperformed US large cap stocks, with the MSCI EAFE Index
posting an 8.7% gain. US small companies were up 2.7%. Real
estate rose 1.6%.
On a year-over-year basis, the broad stock averages were
generally still down by double digits. International stocks are a
notable exception, with an almost flat return for the past year,
providing renewed validation that globally diversified portfolios
can help reduce portfolio volatility. International stocks
continue to reflect relative value compared to most US markets.
Having finished their worst year on record in 2022, bonds were
up nearly 3% or more during the highly volatile quarter.
|
|
|
S&P 500 |
7.48% |
-7.75% |
Russell 1000 Growth |
14.36% |
-10.91% |
Russell 1000 Value |
0.99% |
-5.96% |
Russell 2000 Value |
2.73% |
-11.63% |
Dow Jones US Real Estate |
1.57% |
-18.70% |
MSCI EAFE (net) |
8.65% |
-0.79% |
MSCI Emerging Markets (net) |
3.97% |
-10.39% |
Bloomberg U.S. Aggregate Bond |
2.96% |
-4.78% |
Bloomberg Municipal Bond |
2.78% |
0.26% |
Bloomberg High Yield Bond |
3.57% |
-3.35% |
Data from Northern Trust Asset Management |
Looking ahead, many of the same concerns that vexed investors
last year remain concerns this year. Inflation remains a hot
spot with the Fed. Saying that “inflation remains elevated,” the
Fed’s rate-setting Federal Open Market Committee (FOMC)
re-affirmed its commitment to a long-term inflation target of
2%, adding that it “remains highly attentive to inflation risks.”
Noting the economy’s modest growth and “robust” job creation,
the FOMC also called the banking system “sound and resilient,”
but warned of the likelihood of “tighter credit conditions”
that could slow or choke off economic growth. All of these
are factors that have been echoed by private economists and
equity market analysts as well, highlighting the uncertainties
on all sides. Nevertheless, the Fed’s historically aggressive rate
hikes are almost certainly near completion, perhaps allowing
more stable conditions upon which to make decisions. That
would be a positive and welcome development.
As always, we encourage you to seek out the guidance of your
CNB Wealth Management team to navigate the short-term
bumps on the path to your long-term goals.
Data as of 3/31/2023.
This material is provided for general information purposes only. Investments and insurance products are not FDIC insured, not bank deposits, not obligations of, or guaranteed by Canandaigua National Bank & Trust or any of its affiliates. Investments are subject to investment risks, including possible loss of principal amount invested. Past performance is not indicative of future investment results. Before making any investment decision, please consult your legal, tax or financial advisor. Investments and services may be offered through affiliate companies.