Following a tumultuous end to 2022, markets rallied in January amid optimism that global central banks would soon halt interest rate hikes – with the possibility of even cutting rates by the end of this year.
A 6% jump in the broader equity markets during January was quickly halted by stronger-than-expected February economic data. The U.S. economy gained almost 40% more jobs than predicted by economists, U.S. consumer spending rose by the most in nearly two years, and there were still approximately two jobs for every unemployed worker. The key takeaway from the jobs report was that the Fed still had plenty of runway left to achieve their goal of cooling the economy/inflation. Thus, came a weaker February with equities falling almost 3%.
By the end of the quarter, several significant U.S. bank failures made headlines, while Swiss regulators forced the takeover of banking giant Credit Suisse. Triggered by fears of banking contagion, investors fled from regional banks and other risky investments. As these fears began to ease, investors remained steadfast in their beliefs that the Federal Reserve would slow rate hikes and perhaps even pivot to a rate cut. Following the March FOMC meeting, in which the Fed indicated a 25-basis point hike, a step-down from the several 50bps and 75bps hikes we saw during 2022, equities began their rally to end the quarter up 7%.
Market performance
Equities
U.S. equities whipsawed throughout the quarter: an initial surge in January, a subsequent decline in February, and a robust rally in March. Growth stocks (+14%) significantly outperformed value (+1%) after a year of value domination, while large-cap (+7%) continued to outperform both its mid-cap (+4%) and small-cap (+3%) counterparts. The technology sector was the top performer, bolstered by prospects of a less aggressive monetary policy, which revitalized interest in growth stocks. Conversely, the financial sector trailed behind, suffering a 6% decline due to pressures faced by regional banks.
International equities gained (+8%) in the first quarter of 2023, on the heels of a weaker U.S Dollar and signals that central bank officials may pause rate hikes later this year. The start of the year brought a fresh sense of optimism, given the reopening of China’s economy. That was, until, US-China tensions escalated, followed by a widespread loss of confidence in European banks, which brought returns down. Emerging markets, while positive for the quarter (+4%), lagged developed market equities.
Fixed income
Emerging from their worst annual returns in history, U.S. bond markets regained some lost ground in the first quarter as yields fell all along the curve, with the largest decrease in the intermediate maturities (2-10-year yields). Aggregate bonds returned 3%, Long-term treasuries, returning 6.17%, outperformed their intermediate- and short-term counterparts, which saw intermediate treasuries returning 2.27%, short-term treasuries (1-3 years) returning 1.59%, and treasury bills returning 1.12%. Investment grade bonds, returning 3.58%, slightly outperformed their high yield counterparts, which returned 3.57%. The 10-year U.S. Treasury yield, which is more representative of long-term inflation expectations and economic growth, fell by 33 basis points to end the quarter at 3.55%. The 2-year treasury yield, which typically closely aligns with expectations for short-term interest rates, fell by 35 basis points and ended at 4.06%. Despite the rally in treasuries, the yield curve remained inverted on a 2s/10s basis by 58 basis points, suggesting continued uncertainty in the economic outlook.
World Government and Emerging Market bonds rebounded in Q1 as investors reassessed inflation expectations and the prospect of additional rate hikes. Despite the turbulence in the banking sector, characterized by Credit Suisse’s near-collapse and subsequent acquisition by UBS, global central banks pursued hawkish rate hikes. The European Central Bank implemented two 50bps hikes, while the Bank of England executed rate hikes of 50bps and 25bps.
Commodities
Commodities fell during the first quarter (-5%) with energy (-8%) and livestock (-2%) leading the negative returns. Within energy, natural gas, gasoline oil, and heating oil all declined sharply.
Precious and industrial metals (+8%) attempted to boost the broad commodity basket as gold (+8%) achieved a healthy return, followed by silver (+1%), which also ticked up slightly. Price advances in industrial metals were carried by copper (+8%) and aluminum (+1%), which both had positive returns for the quarter.
Real estate
REIT’s saw positive returns during the quarter, jumping close to 2%. Prices bounced back from a year where REIT prices were suppressed due to rising rates and a cooling economy, and the frequency of real estate deals have fallen. Historically, real estate prices respond inversely to rates, so look for increased volatility in the coming quarters.
Continue to buckle your seatbelts
Through all the volatility in this choppy market, equities and fixed income recovered nicely in the first quarter after being battered during 2022. It’s critical to be sure that your plan is well-positioned to handle volatility that 2023 could bring—the path forward from here may be bumpy.
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