Equity markets rose during the month, led higher by developed markets. European markets outperformed all the main regions with a gain of 4.2%. The S&P 500 returned 1.6% in April. Emerging markets underperformed (down 1.1%) due to weakness in Chinese equities (down 5.2%).
While the S&P 500 Index is up a strong 9.2% so far this year, the narrowness of the market has been notable. A recent Goldman Sachs report noted that 90% of the S&P 500’s year-to-date return is accounted for by the largest 15 stocks. Look no further than the FANG stocks which have clocked in a return of more than 30% this year. It has paid to own the largest names in the index. The S&P 500 Equal Weighted Index is up just 3.3% this year, nearly 600 basis points behind the S&P 500 (market cap weighted index).
Interest rates were largely unchanged during the month (also reflecting relative disregard for the regional banking issues). The 10-year Treasury rate started the month at 3.48% and ended at 3.44%. The Bloomberg US Aggregate Bond Index gained 0.6%. Riskier credit slightly outperformed the core bond index. The ICE BofA US High Yield market gained 1.0%.
Unlike the bank failures in March, the leadup to First Republic Bank’s failure was largely shrugged off by markets. In fact, at the end of the month, the CBOE Market Volatility Index (VIX) hit its lowest level since 2021. First Republic’s failure is the second largest bank failure in US history and makes it the 3rd bank to enter FDIC receivership since March. Bank failures have been relatively modest over the past decade—and even this years’ failures are significantly less than the thousands of banks that failed during the Savings & Loans Crisis of the 1980s or hundreds of banks that went under in the wake of the Great Financial Crisis.
The month was filled with mixed data on the economy as investors waited for the May Federal Reserve meeting. Economic growth slowed as first quarter real GDP growth came in at 1.1%, which was below consensus of 1.9%. It was a notable slowdown from 2.6% GDP growth in the previous quarter. However, first quarter GDP was not a result of weak consumer spending (real personal consumption expenditures increased 3.7% in the quarter). The drag on first quarter GDP was declining business inventories.
Leading indicators on the economy continue to worsen. The Conference Board Leading Economic Index (LEI) declined further in its latest March reading—falling well into recession territory and its lowest level since November 2020. The Conference Board “forecasts that economic weakness will intensify and spread more widely throughout the US economy over the coming months, leading to a recession starting in mid-2023.” According to the Conference Board, there is a 99% probability of a recession in the next 12 months. It very much seems the consensus view is that a recession will happen in the second half of 2023 or early next year. Whether or not that comes to pass (we think it does), the equity and credit markets are not priced for a recessionary environment.
The May 2-3 FOMC meeting was the anticipated event throughout much of April. Despite banking stress and inflation double the Fed’s 2% target, it was largely expected that a 25 basis points increase in the fed funds rate was in the works (bringing the target range to 5%-5.25%). The Fed followed through on this, which is now widely expected to be the final rate hike in the current hiking cycle. The CME futures market has it at a 100% certainty that the Fed will cut rates multiple times between now and the end of the year. This is one of the big divides in the market—the Fed and Chair Powell want to hold rates at these levels for an extended period; however, the market is expecting a U-turn in short order.
We did not make any portfolio changes in the month of March. Our core equity allocations remain aligned with the All Country World Index (ACWI) (roughly 60% US stocks, 30% developed int'l and 10% emerging markets). In the core we maintain a focus on "all-weather" companies through our active fund managers. These are companies that have strong balance sheets, and are market leaders in their respective industries. Because of this focus we are underweight technology vs. the index. Our core equity portfolio also has a tactical tilt to small-cap stocks which contributes to the underweight in technology. We find small-cap stocks attractively valued vs. large-cap stocks and we recognized meaningful out-performance vs. the S&P 500 until the March bank failures. Since then all out-performance was given back and then some, however we remain disciplined as valuations remain attractive. Relative and historical small-caps have been the best performers coming out of a recession.
Within core fixed income we are underweight US Treasuries vs. the Bloomberg Aggregate Bond Index (AGG) and overweight investment grade corporates and high yield as both provide more attractive yields with what we believe to be manageable credit risk. We are still underweight duration relative to the index but we have extended duration in portfolios which, in the event of a recession and/or investors flight to safety (because of debt ceiling, war, etc) could provide some price appreciation if bond yields fall.
While we remain cautious about the market and economy, we understand that the “soft landing” scenario is possible (even if the probability is shrinking amid tightening lending standards as a result of the banking issues). Should markets continue higher while economic readings continue to deteriorate, we would likely further reduce risk in portfolios.
Some information contained in this report may be derived from sources that we believe to be reliable; however, we do not guarantee the accuracy or timeliness of such information. Past performance may not be indicative of future results and there can be no assurance the views and opinions expressed herein will come to pass. Investing involves risk, including the potential loss of principal. Any reference to a market index is included for illustrative purposes only, as an index is not a security in which an investment can be made. Indexes are unmanaged vehicles that do not account for the deduction of fees and expenses generally associated with investable products.