The first quarter of 2023 presented plenty of challenges for investors, though it paled in comparison to the tumultuous 2022. Q1 kicked off with a rousing January, with Nasdaq surging 10.7% and the S&P 500 jumping 6.2%. However, the Fed’s eighth rate hike since last March to start February and a moderating CPI report for January threw cold water on Chair Powell’s encouraging signs of a “disinflationary process” and expectations of a Fed pause any time soon. Stocks pulled back in February on the uncertainty.

Global financial markets had flashbacks to 2008-2009 in early March, when Silicon Valley Bank (SVB) and Signature Bank failed and created a mini-banking crisis requiring the FDIC, Treasury, and the Fed to step in to guarantee deposits and restore depositor confidence across the US banking system. There will be reverberations, including restoring banking regulations and oversight loosened in 2018, stricter loan requirements, higher lending costs, and recession risks have risen. However, this is not the 2008-2009 banking crisis that led to the Financial Crisis and Great Recession.

The quick response by the FDIC, Treasury, and the Fed spurred a strong market recovery to end Q1 on a positive note and stocks posted gains across the board. It was the second straight quarter of gains for stocks. In a near mirror image of 2022, the tech-heavy Nasdaq rocketed 16.8% in Q1, while 2022’s leading Dow Jones Industrials only edged higher by 0.4%. Further, growth outpaced value on a broad basis. The benchmark S&P 500 rose 7.0%, reflecting large-cap stocks outpacing small- and mid-caps. The small-cap Russell 2000 gained 2.3% and the mid-cap S&P 400 rose 3.4%, and that included a rough March, posting losses of 5.0% and 3.4%, respectively.

Overseas, the benchmark MSCI EAFE index jumped 7.7% in Q1 and benefited from a 1.1% decline in the US Dollar. The European Central Bank also raised interest rates twice in Q1, 0.50% each, as inflation remains stubbornly high at 6.9%, ending March. The ECB remains behind the Fed in its inflation fighting rate hikes. Emerging markets rose 3.6% in Q1 but spent time in and out of negative territory.

The Fed raised policy rates two times in Q1, 0.25% each, to 4.75%-5.00% in its continued efforts to stem high inflation in part by slowing the US economy. Since last March, the Fed has raised rates nine times totaling 4.75% to levels not seen since September 2007. Inflation has been steadily declining from its 9.1% high last June to the most recent reading of 5.0% in March (released 4/12/23). The Fed’s goal remains 2.0% and market expectations are for at least one more 0.25% hike at its May FOMC meeting. The market is pricing in one or more interest rate cuts by year-end; however, the Fed is not projecting a rate cut until 2024. 

Intermediate-term interest rates fell in Q1, led by the benchmark 10-year Treasury Note yield, which fell 0.40% to 3.48%. The Bloomberg Aggregate Bond Index gained 3.0% in Q1, following its worst year ever in 2022. Short-term interest rates edged higher with the Fed rate hikes, and further inverted the yield curve, which is a widely watched indicator for a future recession (short-term rates higher than long-term rates). While all recessions have been preceded by an inverted yield curve, not all inverted yield curves have resulted in recession.

The Outlook

Despite the headwinds, the US economy has remained resilient; the Atlanta Fed’s GDPNow is forecasting 2.5% annualized real growth for the First Quarter, while unemployment sits near 50-year lows at 3.5% as of March. However, forecasts are for a slowing economy and lower corporate earnings by year-end and into 2024, as well as an uptick in unemployment.  The mini-banking crisis noted above has further complicated the Fed’s inflation fight. Inflation has trended down as expected, as noted above, given the Fed’s aggressive tact of raising rates, but it has been stickier than anticipated. The Fed has been trying to engineer a soft-landing while hitting its 2% inflation target. While a soft-landing/shallow recession remains the baseline later this year or 2024, anticipated reverberations of the mini-banking crisis have raised risks of a moderate recession. The risk of a severe recession remains low.

We are encouraged by the solid gains in both stocks and bonds in the first quarter. The extreme volatility we experienced in 2022 was largely the market discounting future recession risk due the Fed’s aggressive rate hikes to quell high inflation. The question markets are calibrating is how much was already discounted in 2022 and how much remains. The answer lies in what type of recession occurs if we indeed enter one.

Volatility remains in the forecast, and we urge investors to remain resilient with their investment portfolios and maintain a disciplined, long-term focus. As noted at the beginning of the year, we anticipate a return of the virtues of diversification and the traditional risk relationship between stocks and bonds.

The market environment for 2023 remains challenging, and we continue to encourage investors:

• Remain well-diversified
• Maintain discipline and patience
• Focus on the long-term
• Review your Risk Tolerance

Call your Nelson Advisor today at 800-345-7593 to discuss any concerns and review your portfolio.   

~Your Nelson Securities Team    

*Past Performance is No Guarantee for Future Results

Recession risk and concern has been on the rise since the Fed started aggressively raising policy interest rates in March 2022 to rein in high inflation that spiked during and after the Covid Pandemic. The Fed has raised rates nine times totaling 4.75% and we may get another 0.25% hike in May. But that could be it as a Fed pause is anticipated by the market. The inflation rate has been steadily on the decline from its 9.1% peak last June but remains uncomfortably high at 5.0% (March CPI) and above the Fed's 2% target. While supply chain constraints have improved dramatically, the Fed has been trying to slow the economy in its inflation fight. But the economy has been resilient, and unemployment has remained near 50-year lows. However, the economy and corporate earnings are slowing, and a rise in unemployment is expected. Uncertainty remains on how severe the probable recession may be. The baseline remains a soft-landing/shallow recession, but risks have been rising for a deeper recession.   

As Capital Group notes: "The good news is that recessions generally haven’t lasted very long. Our analysis of 11 cycles since 1950 shows that recessions have persisted between two and 18 months, with the average spanning about 10 months. For those directly affected by job loss or business closures, which can feel like an eternity. But investors with a long-term investment horizon would be better served looking at the full picture."

Further, "Recessions have been relatively small blips in economic history. Over the last 70 years, the U.S. has been in an official recession less than 15% of all months. Moreover, their net economic impact has been relatively small. The average expansion increased economic output by almost 25%, whereas the average recession reduced GDP by 2.5%. Equity returns can even be positive over the full length of a contraction since some of the strongest stock rallies have occurred during the late stages of a recession."

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