Providing a reprieve from the prior year’s returns, the S&P 500 increased by 7.5% over the opening quarter of 2023, with mixed underlying sector returns. The Fed continued its rate hiking campaign but eased the pace at which it did so. International markets followed suit, with the MSCI EAFE gaining 8.5% on the quarter as fears of an energy crisis in Europe due to a cold winter subsided. As measured by the MSCI Emerging Markets Index, emerging markets returned 4.0% as China reopened its economy, but tensions with the US developed. Fixed income markets also began their recovery, with the Bloomberg US Universal posting a gain of 2.9% on the heels of rising interest rates. Despite the Fed’s best efforts, the economy showed mixed messages, with GDP rising and the labor market holding strong. Looking ahead to the rest of 2023, we expect a mild recession but anticipate positive portfolio returns on the year.
The S&P 500 gained 7.5% throughout the first quarter of 2023, starting off the year in a sharp contrast to 2022. Although overall positive, the large-cap index had a turbulent three months, rising in January, dipping in February, and recovering again in March. The year started with mostly encouraging economic indicators. The consumer price index (CPI), the primary indicator of inflation, posted its largest monthly decline since April 2020, and inflation continued to trend downward. The Federal Reserve (Fed) raised rates by only 25 basis points in February, the smallest increase since the hiking campaign began in March 2022, but higher-than-expected inflation data and persistent labor market strength spooked investors later in the month. March opened with the 10-year treasury yield topping 4.0% for the first time since November 2020 and the 2-year/10-year yields widening to the largest negative spread since 1981. The Fed increased interest rates by another 25 basis points in March amidst a miniature baking crisis ignited by the collapse of Silicon Valley Bank and Signature Bank. However, government agencies quickly stepped in to support banks, easing investor concerns and supporting a market recovery.
Underlying returns were wide-ranging in Q1. Seven of the eleven sectors in the S&P 500 finished the quarter in positive territory, with growth sectors technology, communication services, and consumer discretionary posting double-digit gains. On the other hand, value sectors struggled more throughout the quarter, with financials and energy posting losses due to apprehension around banks and weakening oil prices.
Large-cap stocks outperformed small-cap stocks, and growth stocks handily outpaced value stocks throughout the quarter. While the Russell 1000 Value index only gained 1.0%, the Russell 1000 Growth index posted 14.4% in the quarter, as investors flocked to stocks with strong cash positions that benefitted the most from lower interest rates.
International developed markets followed the same trends as US markets throughout the first quarter, with the MSCI EAFE Index gaining 8.5%, outperforming the S&P 500 for the second consecutive quarter. The Eurozone started the quarter with worries that member countries would struggle to meet their energy needs as the Russia-Ukraine war raged on. Inflation persisted for a bit, but when data indicated the region would avoid a recession thanks to government support and a warmer winter, sentiment improved, and inflation eased. The UK continued to struggle more than most other countries within Europe, plagued by higher inflation and slow growth. Despite a tumultuous month, Switzerland posted one of the developed markets’ best returns in March. Credit Suisse collapsed during the month, shadowing the US banking sector’s troubles, but the government quickly stepped in and persuaded UBS to purchase the bank in a bid to prevent a banking crisis. Elsewhere, Spain was one of the best-performing countries in Q1, thanks to a more service-oriented economy and a positive contribution from tourism. Japan also buoyed the index as Tokyo’s price inflation slowed for two of the year’s first three months.
Emerging markets followed developed markets’ suit, and the MSCI Emerging Market Index rose 4.0% in the quarter. It was a bumpy ride as the index increased in January, gave back nearly all the gains in February, and recovered modestly in March. Taiwan entered a bull market during the quarter on the heels of foreign investment in microchip companies. China started the quarter off hot, as the post-COVID rally continued, and domestic activity grew during the Lunar New Year. However, Chinese stocks plummeted in February as US-China relations worsened with the shooting down of Chinese spy balloons over the US. China’s economy struggled throughout the quarter as the property market remained sluggish, and the country set its lowest annual growth target in over 25 years.
Over the first three months of the year, the Bloomberg US Aggregate Index rose 3.0%, and the broader Bloomberg US Universal Index gained 2.9%. Positive bond returns were driven by falling inflation and expectations that rate hikes were coming to an end, commencing a slow recovery from bonds’ worst year in history last year.
The yield on the 10-year US treasury decreased 0.4% during the quarter, ending at 3.48% after a turbulent three months. In January, the 10-year treasury yield saw its most significant monthly decline since March 2020 (down 36 bps), then its largest jump in nearly six months in February (up 53 bps), and finally, an even larger decline in March (down 53 bps). The yield curve remained inverted throughout the quarter, with the 2-year and 10-year yields widening to the largest negative spread in 40 years at one point. Short-duration yields, which are closely tied to Fed rate moves, declined and the 2-year Treasury fell 35 basis points and ended the quarter at 4.06%. With shorter maturity-bond yields persisting above longer-maturity bond yields, a recession is becoming more likely, though expected to be mild given strength in the labor market. Credit spreads narrowed in the quarter as the Fed inched closer to ending rate hikes, and the economy remained fairly resilient.
US gross domestic product (GDP) grew at an annualized rate of 2.7% over the fourth quarter of 2022, the latest period for which data are available. Consumer spending contributed to the increase in GDP, but the rate at which consumers spent decelerated from Q3. Inflation has continued to decrease throughout the first three months of 2023, and although it looks as though it has peaked, it remains well above normal levels. Consequently, credit card debt is increasing faster than consumers can pay it off, indicating an increase in defaults down the line.
The labor market remained strong throughout Q1. Despite the Fed’s best efforts, the unemployment rate hovered near historic lows during the quarter (3.5% as of March). The number of job openings increased during the quarter but showed early signs of easing. Employers struggled to fill the positions, with the number of unemployed persons per job opening remaining remarkably low.
The Fed wants to see higher unemployment rates in order to signal receding inflation. Jerome Powell and the team continued their campaign to combat inflation, though easing the rate at which they did so during the quarter. Thanks to tightening financial and economic conditions, the Fed raised rates by just 25 basis points in February and March, marking the most minor increases since the hiking campaign began in March 2022. Investors generally expect one final 0.25% hike in Q2, then three 0.25% cuts by the end of the year, despite the Fed officials indicating that interest rates will remain stable for the year.
Notwithstanding turbulent conditions, the first quarter of 2023 provided a welcome reprieve from the unprecedented past year. Both equities and bonds finished in positive territory, and the consumer proved resilient despite persistent inflation. While there is broad consensus that a recession is on the horizon, consumers have yet to cut back spending as much as the Fed would like. Employers are fighting to find workers, and consumer spending, which makes up about two-thirds of the U.S. GDP, has proven resilient.
We believe it is unlikely that consumers will be able to maintain their spending levels throughout the rest of the year and believe a recession will develop later in 2023. We anticipate the recession to be relatively mild. Unemployment remains near record lows and should not rise sharply even during a recession as aging workers continue to exit the workforce. Markets have also largely priced in a recession, as 2022 returns were deeply negative despite solid earnings and economic growth. Earnings are projected to fall this year, but the S&P 500 has historically posted a high single-digit return during years of falling earnings, as forward-looking investors tend to price in earnings declines before they occur. Even with a mild recession, we expect stocks to continue their upward trend throughout 2023. We see relatively attractive return potential among international equities, which are more discounted than their domestic counterparts. Additionally, bonds offer the highest yields in 15 years, and as the Fed ends its hiking campaign, returns should stabilize and present attractive income opportunities.
This information is for educational purposes and is the opinion of Aldrich Wealth LP (“Aldrich Wealth”). Facts and figures are believed to be from reliable sources, but no liability is accepted for any inaccuracies. Nothing in this commentary should be construed as an investment recommendation. Past performance does not guarantee future results and all investments involve risk. Aldrich Wealth is an investment adviser registered with the U.S. Securities and Exchange Commission.
Meet the Expert
Partner + Chief Investment Officer
Darin Richards, CFA®
Aldrich Wealth LP
Darin joined the Portland wealth management firm in 2004, bringing more than a decade of investment and financial consulting experience with him. As chief investment officer for Aldrich Wealth, Darin is responsible for developing, and implementing our investment philosophy and leading the investment committee. He works directly with some of our most complex and largest clients and also…
- Series 7 and 63 security exams
- Chartered Financial Analyst (CFA®)