This article is brought to you in collaboration with our colleagues at Laird Norton Wealth Management from their post, Economic Flash: Signs of Fragility.
U.S. Economy: More Fragile
As the Fed pressed forward with tighter monetary policy, most economic data indicated an economy that continues to slow and flirt with recession, with retail sales falling 0.4% and unemployment up to 3.6% from 3.4%. Importantly, the first real consequence of high interest rates manifested in the collapse of Silicon Valley Bank and Signature Bank, with the Fed implementing a backstop program to reassure all depositors.
U.S. Stocks: Resilient Rebound
During the month, large-cap US stocks had fallen nearly 5% peak-to-trough before optimism grew that deteriorating economic data and tighter liquidity conditions would force the Fed to reconsider its course. Large-cap stocks finished the month up over 3.6% with big gains from rate-sensitive tech (+12.1%) and communications (+10.4%). Small-cap stocks, which are more sensitive to both economic growth and credit disruption, did not benefit and were down 4.8%.
Foreign Stocks: Ditto the U.S.
While the banking crisis extended overseas, as long-struggling Credit Suisse was taken over by rival UBS, so too did the recovery and rapid turnaround that marked U.S. large-cap: Both non-U.S. developed and emerging markets posted comparable returns to the U.S. at month-end. While ongoing war in Ukraine weighed on Eastern Europe, Asia was broadly positive, with China (+4.5%) benefitting from relative economic strength.
Fixed Income: Longer Was Better
The Fed’s preferred inflation gauge, the Core PCE price index, slowed more than expected but inflation remains a concern even if the latest monthly increase brings the annualized rate down to 3.6%. This result, coupled with the banking turmoil, contributed to interest rates falling. With this backdrop, longer-maturity bonds outperformed in most sectors of taxable and tax-exempt, whereas cash and equivalents lagged.
Real Assets: Infrastructure Leads
As investors focused more on economic fragility than inflation, real assets quietly struggled with the notable exception of infrastructure (+2.4%), which benefits from both defensive characteristics and secular tailwinds. Both REITs and commodities were in negative territory. Over the last 12 months, infrastructure equities are down just 3.5% whereas broad-based commodities are down 12.5% and REITs are down 19.4%.
Alternatives: Small Negatives Mostly
Hedge fund strategies continued to post modest or flat returns through the persistent volatility in both the stock and bond markets, although deteriorating credit conditions offer both risks and opportunities to the space going forward. Managed futures strategies, which are geared to take advantage of pricing trends, suffered in March as the markets did an about-face and caught many managers off-guard.
Source of data: Bloomberg
Equities Total Returns
Fixed Income Total Returns
The risk that the Fed may raise rates too far too fast has been one we have highlighted since early 2022, when it became clear the Fed would start to raise rates. Cash, core fixed income (in 2023), and diversifiers have generally benefited portfolios in light of this environment. Surprisingly, equities have generally held up well in 2023 – despite turmoil in the banking sector. But that is mostly due to the resurgence in the mega-cap tech stocks. Investors are likely expecting that a recession will lead to lower interest rates and ultimately help tech stock valuations. It is way too early, we think, to take the market rebound as a sign that all is well.
As we stated back in January 2022, we are likely in the midst of a market regime change for a variety of reasons, the ramifications of which continue to surface. For example, the trillions in bank deposits that were getting essentially zero or negative interest have started to move out of banks into higher-yielding money market accounts. This has been creating stress primarily for the regional banks, some of which seemed to have forgotten some of the basic rules of banking, including how to compete for deposits. With that said, there was some encouraging news on this front in the recent weekly H.8 report released by the Federal Reserve, which indicated deposit outflows seem to be abating.
We will discuss in detail what recent developments mean for markets and our portfolios in our upcoming quarterly commentary.
Glossary of Indices
U.S. Large Capitalization = S&P 500 Index
Tracks the performance of a representative sample of 500 leading companies in the major industries of the U.S. economy.
U.S. Small Capitalization = Russell 2000 Index
Tracks performance of the 2,000 smallest companies in the Russell 3000 Index, representative of the U.S. small capitalization equity market.
U.S. Growth Equities = Russell 3000 Growth Index
Tracks the performance of those Russell 3000 companies that have higher price-to-book ratios and higher forecasted growth values.
U.S. Value Equities = Russell 3000 Value Index
Tracks performance of those Russell 3000 companies that have lower price-to-book ratios and lower forecasted growth values.
International Equities (Developed Countries) = MSCI EAFE Index
A float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. Consists of the stock market indices of these 20 developed countries: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.
Emerging Market Equities = MSCI Emerging Markets Index
A float-adjusted market capitalization index designed to measure equity performance in the major emerging markets. Consists of the following 25 emerging-market -country indices: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
U.S. FIXED INCOME, TAXABLE
U.S. Aggregate Bond = Barclays Capital U.S. Aggregate Bond Index
Covers U.S. dollar-denominated, investment-grade, fixed-rate, taxable bond market consisting of SEC-registered securities. Includes U.S. Treasuries, U.S. agency bonds, U.S. corporates, mortgage-based securities (MBS, CMBS) and asset-backed securities (ABS).
TIPS (Treasury Inflation-Protected Securities) = Barclays U.S. Treasury Tips Index
Measures the performance of TIPS of various maturities issued by U.S. Treasury.
INTERNATIONAL FIXED INCOME
International Developed Bonds = BofA Merrill Lynch Global Government Bond II ex U.S.
Measures the performance of non-U.S. developed-market government bonds on an unhedged currency basis.
Emerging Market Bonds = BofA Merrill Lynch Emerging Markets Sovereign
Bond Index Measures the performance of emerging markets government bonds on an unhedged currency basis.
U.S. FIXED INCOME, TAX-EXEMPT
Intermediate Municipal Bonds = Merrill Lynch Municipals, 3-7 Yrs Index
A subset of The Merrill Lynch U.S. Municipal Securities Index, including all securities with a remaining term to final maturity of between 3 and 7 years.
Municipals, Broad Market = Merrill Lynch Municipal Master Index
Tracks the performance of U.S. dollar denominated investment-grade tax-exempt debt publicly issued by U.S. states and territories, and their political subdivisions.
Absolute Return Funds = HFRX Absolute Return Index
Tracks the performance of hedge funds aiming to provide stable performance regardless of market conditions. Such funds tend to be less volatile and less correlated to market benchmarks. Data is based on estimates for the most recent months, may not include performance for the last business day of the indicated month and is subject to revision.
Market Directional Funds = HFRX Market Directional Index
Tracks the performance of hedge funds that add value by participating in the direction of various financial markets. Such funds characteristically have higher expected volatility than Absolute Return strategies (see above). Performance data is based on estimates for the most recent months, may not include performance for the last business day of the indicated month, and is subject to revision.
Equity Volatility = CBOE VIX Index
Aims to measure investor expectations for near-term stock-market volatility as conveyed by the pricing of stock options on the S&P 500 index that mature within 30 days.
Implied Inflation = 10-Yr TIPS Implied Inflation
Gauges investor expectations for future U.S. inflation based on the difference between the yield on a 10-year TIPS (Treasury Inflation Protected Security) and the yield on a nominal 10-year Treasury.
Gold Spot $/oz.
An index intended to measure the current price of gold, based on futures contracts deliverable in the following month priced in U.S. dollars per Troy ounce.
Oil = Brent Crude Oil Spot Price $/bbl
Brent Crude Oil refers to a particular grade of crude oil often quoted in financial reports as the global benchmark for the price of oil. It typically trades at a premium to the West Texas Intermediate price.
U.S. Dollar = Trade-Weighted U.S. Dollar Index
Value of the U.S. dollar relative to a composite of 26 currencies of major U.S. trade partners, weighted based on trade data.