First Quarter 2023 Review and Outlook

Stocks and bonds posted solid performance in the first quarter of 2023.  The S&P 500 gained 7%, the MSCI International EAFE stock index gained 9%, and the aggregate US bond market gained 3%.     

Analysis

Inflation will likely remain the critical variable for financial markets in 2023. Financial markets were driven higher primarily by modestly lower inflation data and the expectation that inflation would continue its downward path. Inflation remains high when viewed from a longer-term perspective. As seen in the chart below, current inflation is at 5.5% measured by the most recent reading of Personal Consumption Expenditure (PCE) inflation excluding food and energy.  Financial markets are hoping for and depending on the downward trend to continue.  We will see, it is far from certain inflation can get below 2.5% to 3% any time soon.  A pause in the downward trend of inflation would likely cause stock and bond market weakness. 

The fallout from the end of the extremely stimulative monetary policy of the past decade continued to cause problems.  The most recent was the failure of two very large banks, Silicon Valley Bank and Signature Bank.  Neither bank failed due to a weakening of credit or a soft economy. Both failures were prompted by the upward movement in interest rates led by the Federal Reserve’s actions to control inflation.  Higher interest rates created losses in value from their long-maturity U.S. Treasury securities which were not properly hedged or managed by the banks or their regulators. 

Portfolio Activity

During the quarter emerging market stocks were removed from our investment portfolios. Our investment selection criteria require attractive risk-adjusted returns. When assessing emerging market stocks we see higher risk which is not compensated for by higher expected returns. The higher risks come from the pure nature of emerging markets.  For example, stocks in Russia previously composed about 3% of emerging markets investments.  Due to the events of the past year these have gone to zero.  The weight from China has increased to nearly one-third of the emerging markets segment.  The Chinese economy is moving farther away from market-based capitalism, which means it is moving farther away from the best environment to own stocks.  New rules in China allow significant government control of companies from owing as little as 1-2% of the company stock. These actions add risk to Chinese investments.  Additional emerging market concerns come from Taiwan, the second largest component of the emerging markets sector with a 17% weighting. Taiwan is in a risky position regarding the long-term future of their capitalist economy due to the increasing influence of China. 

Proceeds from the sales of emerging market stocks was invested in U.S. company stocks. 

Conclusions

1. Free money* has ended and brings unknown ramifications. Bank failures were the surprise of the first quarter. Be wary of further fallout.
2. Watch inflation like a hawk. It needs to keep coming down for financial markets to stay strong.
3. Maintain a modest underweight to stocks. Bonds now provide a more attractive alternative to stocks on a relative basis. Until inflation is contained, stocks will be challenged by restrictive monetary policy. Valuation levels have fallen but remain above average on several metrics. Slaying the inflation dragon will take time and may likely require more than the arsenal of the Federal Reserve. 

Article by Tom Gunderson CFA

* Extremely low interest rates managed by the Federal Reserve along with high money supply growth.

ViaWealth, LLC is a registered investment adviser.  Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.  Investments involve risk and, unless otherwise stated, are not guaranteed.  Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.