A Month At-A-Glance
- Global equities rose in April amid regional banking stress and worsening leading economic indicators.
- Despite the worries, the economy remains resilient and has yet to contract.
- Investors waited for the Fed’s early May rate decision—widely believed to be the last rate hike in this cycle.
- Regulators seized First Republic Bank and sold its assets to JPMorgan Chase
Equity markets rose during the month, led higher by developed markets. European markets outperformed all the major 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%).
Unlike the bank failures in March, the leadup to First Republic Bank’s failure was largely shrugged off by markets. First Republic’s failure is the second largest bank failure in US history making 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.
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 essentially 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%.
The month was filled with mixed economic data as investors waited for the May FOMC meeting. 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 (actual 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.” It 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, the equity and credit markets are not priced for a recessionary environment.
The May 2-3 FOMC meeting was anticipated throughout much of April. Despite banking stress and inflation doubling 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 significant 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 made an asset allocation change in April. Overall, a slight reduction in equities is appropriate given the attractive yields in cash and fixed income, mixed economic data, and uncertainty surrounding future monetary policy from the Federal Reserve.
Companies are likely to continue seeing their margins come under pressure and their forward earnings estimates revised downward. Additionally, the unemployment rate could rise, given tighter financial conditions, adversely affecting financial markets, including equities.
As we move through this process, adding back to equities should be warranted, especially for sub-classes that do well following an economic slowdown. In the future, the Asset Allocation Committee will continue to review conditions for this change and adjust allocations as appropriate.
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