Q1 2023 Recap
Indices YTD Performance (1/1/23- 3/29/23)
The US Banking system, primarily regional banks, are under attack, the Fed increased interest rates by another 0.5% during the quarter, Q4 2022 earnings were down 5% year-over-year, Corporate profits fell 2% in Q4 2022, and inflation remains sticky.
Yet the stocks with the highest valuations (i.e. more expensive companies) have lead the market (look at the tech heavy Nasdaq).
Investing is not easy. Just when you think something is out of favor, that’s when a rally typically occurs.
That is why simply buying and holding stocks in a broad market index is a strategy that is very hard to beat.
We are also experiencing a fundamental shift in how companies operate.
This quote from Marc Benioff, CEO of Salesforce, says it all
“You all know that we’ve never had an efficiency focus in the company before because we’ve had 24 incredible years where we’ve had to just grow, grow, grow."
Even Facebook labeled a recent press release: “Year of Efficiency”.
It seems absurd for a public company to announce that they are primarily focused on profitability and making their companies more efficient.
But in an environment where money was essentially free, stories of growth, innovation, AI/metaverse, fake meat, etc. triumphed.
Profits come later, or never.
Interest Rates:
We have officially surpassed the 1-year mark since the Fed started raising interest rates.
We started with rates at essentially 0% in early 2022.
Since then, the Fed has raised interest rates on nine different occasions bringing the Fed Funds rate to 4.75 – 5%.
The Fed has been adamant about being ‘data dependent’ with their decision making. But at what point do they implement common sense and maybe hit the pause button.
It seems like the Fed landed on 0.25% increase in March because they didn’t want to show markets they were concerned by pausing. Raising rates by 0.50% would’ve exacerbated the problem further, so yeah, 0.25% it is!!
We did receive strong economic data during the quarter which made investors believe that the Fed was going to keep raising rates and go ‘higher for longer’.
Then the SVB and banking crisis took place which highlighted how fast things changed and the trickle down effect of higher interest rates.
As rates rose, the value of the bond holdings the banks own fell substantially.
The unrealized losses that are piling up at these banks reminds me of my own portfolio…
Q1 2023 bank earnings could very well be atrocious. If they were required to sell some of their securities to be able to redeem customer deposits, they will likely show a great deal of losses. We will see how this all shakes out.
Going forward, expect these Fed meetings to be a complete toss up. We don’t know what they are going to do.
Banks:
In a recent blog, I touched on the SVB debacle and what it could mean for the banking sector.
These events really opened peoples eyes. Customers/businesses are leaving the smaller banks and going to the bigger banks in full force:
Not only are customers migrating to bigger banks, they are starting to realize the interest rates they can earn in money market funds and US Treasury bonds:
As customers pull deposits from these regional banks and interest rates continue to be very volatile, this will ultimately lead to stricter lending standards which is not good for the overall economy.
Inflation:
Inflation is like that one guest at your party that you didn’t even invite, yet they just refuse to leave.
CPI is at 6% and was up 0.4% month-over-month as of February. If you were to annualize that number, that gets you to about 4.8%, which is still well above the Fed’s inflation target of 2%.
You may ask yourself, “why is 2% their inflation target?”
The joke is that they landed on 2% because 1% seemed to low and 3% seemed too high…
It seems arbitrary, with no meaning or purpose, but it’s worked for them and Powell seems committed (he only mentioned the 2% inflation goal eleven times in his latest press conference…)
The Fed could be fighting to maintain their credibility based off how wrong they have been over the years.
We will see how much pain they are willing to inflict to get us back down towards 2%.
Worth noting that deflationary metrics may be coming into play as well:
people are nervous about banks, spending less.
banks hesitant to give out loans because rates are too volatile (lower consumption).
tighter lending hurts companies who aren’t cash flow positive.
student loans start back up in September 2023, regardless of how the Supreme Court rules.
Services inflation is the real problem – wages have shown signs of easing but still elevated:
Unemployment Rate:
Unemployment is still at a historically low rate of 3.6%. The Fed is forecasting unemployment rate to reach 4.5% at the end of 2023.
They did admit that “it’s a highly uncertain estimate”, and they are known (like many others) to be terrible forecasters.
But to give you a sense of the damage that would need to be down in order to go from 3.6% to 4.5%, that would be roughly 1.5 million jobs lost…
Conclusion:
Confidence was so high in prior years, this lead people to over spend and be over confident (i.e. take more risks).
Inflation has stuck around and people are starting to feel the crunch. People grow accustomed to new expenses which make them hard to get rid of.
But let’s end on an optimistic note.
When the S&P 500 ends Q1 above the December lows (which we are on track for), the rest of the year looks quite good:
Also love this tweet from Ben Carlson:
We are in this for the long run…
Disclosure: This material is for general information only and is not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
All indices are unmanaged and may not be invested into directly.
All investing includes risks, including fluctuating prices and loss of principal.