|April 2023 Commentary |
As the second quarter of 2023 gets underway, we thought some commentary highlighting the current state of the market would be helpful. We find it useful to identify the themes we think are important and monitor those themes as the year progresses.
Before we jump into the themes, it is important to point out that the S&P 500 was up over 6% through the first quarter of 2023!
One of the major drivers of the positive return this year has been technology, while defensive and value sectors of the market have underperformed. This change in market dynamic reflects a positive shift in investor sentiment as factors that caused volatility throughout the last year have shown signs of normalizing.
There have also been new concerns that have emerged to start the year as failures among regional banks sent shocks through investors who were bracing for a wide scale banking issue. Luckily, the banking failures seem to be isolated, and the risk of a "contagion" seems low. Some of this is due to the specific nature of the banks that ran into trouble, as well as the emergency efforts to restore confidence in the banking system by regulators and government institutions.
When considering the factors that have contributed to the market’s resilience and ability to bounce back after the correction we saw in 2022, we look at themes such as inflation, the labor market, and consumer spending. All of these factors have the potential to change direction, and the financial stability in the banking system is still something to keep an eye on, but it is worth just acknowledging the current trends and expectations. Inflation One of the Federal Reserve’s core missions is to achieve price stability…or more specifically, bring inflation down to a rate of 2%. Although the inflation rate remains well above the target rate of 2%, we have seen notable improvement as we look at the progression of inflation over the last few months:
November 2022: 7.1%
December 2022: 6.5%
January 2023: 6.4%
February 2023: 6%
As you can see in the speedometer above provided by our friends at City National Rochdale, the current outlook for inflation is neutral with a tilt towards the negative end. While we are encouraged by the direction inflation is moving, there is still ground to cover to get to the Federal Reserve's target. High interest rates and tight financial conditions will continue until the Federal Reserve feels they have a handle on inflation.
The Labor Market
A low unemployment rate is one of the hallmarks of a healthy economy. As we look at the recent labor market data, we are encouraged by the resilience we are seeing.
December 2022: 3.5% unemployment
January 2023: 3.4% unemployment
February 2023: 3.6% unemployment
March 2023: 3.5% unemployment
For some context on the above numbers, the average unemployment going back to 1948 has been 5.73%. The current rate of 3.5% is near an all-time low.
The current outlook for the labor market as outlined above is neutral with a lean towards positive. While unemployment remains at a historically low level, the number of jobs being added to the economy per month is decreasing, as is the growth in employee wages. Overall, we believe the labor market is strong which increases the possibility of the fed pulling off a "soft landing" which refers to their ability to tighten financial conditions without inducing a significant recession.
Consumers are the largest driver of the U.S economy and their spending habits have a large impact on overall economic activity. Consumption accounts for around 68% of the GDP (Gross Domestic Product) calculation. While most think of a rapidly growing GDP as a sign of a healthy and booming economy, it can also contribute to the inflation issue. If consumers are spending at record levels, demand for goods will be higher, which in turn can make it harder for inflation to moderate.
As we look at the PCE index (personal consumption expenditures) we can see that consumer spending is continuing to grow over time, but at a slower rate than it was previously. This may be the sweet spot that allows inflation to moderate while stimulating the economy enough to avoid a significant recession
The current outlook for consumer spending as outlined above is neutral. While it is ideal for consumer spending to be increasing at a slower rate, there is risk for it to start trending in a negative direction month over month if financial conditions continue to tighten. An example of financial conditions tightening further would be if the Federal Reserve continued to raise rates throughout 2023.
The economic themes outlined above all seem to be progressing well, as can be seen in the reaction of the market. However, in the near term, we do expect more volatility as new data comes in and the Federal Reserve weighs its options. There are still many opportunities to be found in the market between high yield structured notes, equities that have fallen way off their all-time highs, and low risk securities like CDs and money market funds providing attractive yields.
We hope this commentary provided some context on the state of the market! Please feel free to reach out to our team if you have any questions.