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The first quarter of 2023 was a welcome bright spot and relief for many fidgety investors. We saw a solid performance and all major equity and fixed-income sectors yielded positive returns.
US consumer inflation rates continued to slow after reaching a multi-decade peak of 9.1% in 2022. Some of the more transitory inflation pressures such as supply-chain disruptions continued to fade. Even with the Federal Reserve’s 25 basis point interest rate increase in both February and March, inflation rose less than expected (0.1%), signaling speculation that further rate hikes may be limited (Source: Bureau of Labor Statistics). We believe the moderating trend will continue in 2023, but it may be difficult to return soon to the stable, low-inflation environment of the past two decades.
Nevertheless, headwinds persist. As Roehl & Yi has always cautioned, quickly spiking interest rates have the potential to slow growth. We are seeing increasing and multiple signs of economic stress on the consumer (as discussed in this edition) and corporate earnings – both of which may be further aggravated by the recent bank failures. Although regulators moved quickly to minimize panic following the collapse of both Silicon Valley Bank and Signature Bank, other regional banks saw an upswing in withdrawals, emphasizing a lack of consumer confidence.
Moreover, though banks are in a better capital position than in prior years, lending standards will likely tighten, thus restricting access to capital. A compounding economic effect will likely be felt with significantly higher interest rates. The final impact of the bank dissolutions remains to be seen in the mid- and long-term, but these failures can have a trailing effect on smaller banks and the entrepreneurs and businesses they serve.
Given all of these circumstances, a recession may be difficult to avoid in the coming quarters, particularly with such stubborn inflation.
There has been much talk in the news about the US dollar and its status as the world’s major reserve currency. It appears to stem from the news that China is beginning to use the yuan in commodity trades with a handful of trading partners, and Brazil and Argentina are exploring the potential for a common currency. While the dollar has declined over the past six months, it remains close to a 10-year high versus the currencies of countries with which the US trades (Source: Schwab.com). A long-term trend toward diversification of currencies in global financial transactions and trade may develop, but it is a huge leap from dollar dominance to de-dollarization.
A highlight of the quarter is the strong US job market with unemployment unchanged at 3.5% by the end of March (Source: US Bureau of Labor Statistics). Though some view the recent job creation as returning jobs lost during the pandemic and not true job growth, employment is a critical measure to watch.
As the markets continue to digest a far more uncertain future, we encourage you to stay vigilant.
During the first quarter of 2023, we have seen a near reversal of what was experienced in 2022.
The S&P 500 was up 7.5%, the Russell 2000 Small-Cap Value Index was up 2.74%, and US 10-year bonds rallied 4.23% from -16.37% in 2022. The biggest story of Q1 was a move to safety. Russell 1000 Growth stocks outperformed Russell 1000 Value stocks by 14:1. Investors flocked for cover in FAANG* stocks and gold, viewed as the ultimate haven, which had its best quarter on record, up 9.15%. The US dollar weakened -1.58% from its positive 5.3% in 2022. International stocks also fared well over prior negative 2022 returns (Source: Morningstar).
*FAANG technology stocks include Meta (formerly known as Facebook); Amazon; Apple; Netflix; and Alphabet (formerly known as Google).
Banking Failures and Economic Consequences
A deposit run that felled both Silicon Valley Bank and Signature Bank has hurt small- and mid-size banks much more than large ones, draining low-cost funding that has fueled profits in recent years. The reverberation of these two failures caused nearly $312 billion in deposits to leave the banking system between March 1 and March 29 (Source: Federal Reserve).
To reduce additional bank withdrawals, many are offering higher yields to account holders. With funding uncertainties, however, bank loan officers will likely need to pull back on new credit offers.
In addition, US banks’ lending capacity is expected to decline by 1% in 2023 as the value of bank stocks wobble and investors reassess the health of regional banks (Source: International Monetary Fund).
These scenarios have negative implications for the economy and gross domestic product in 2023.
The chart below demonstrates that among the 563 bank failures since 2001, Silicon Valley Bank and Signature Bank were among the top three largest to go under (Source: Federal Deposit Insurance Corporation).
US and International Stock Performance
With the recent positive performance of international stocks and speculation about the US dollar, we would like to reiterate that the US dollar remains the primary currency used for trade and financial transactions in the global economy. Further, should there be a move to a less-dominant dollar over time, we do not anticipate the dollar losing its reserve currency status.
The chart below shows international stock versus US stock performance.
The MSCI EAFE Index represents the performance of large- and mid-cap securities across 21 developed markets, including countries in Europe, Australasia, and the Far East, excluding the US and Canada.
The MSCI USA Index measures the performance of large- and mid-cap segments of the US-only market. With 626 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in the US.
Over the last 51 years, US dollar stocks outperformed international stocks more than 63% of the time during that period (Source: J.P. Morgan).
Consumer Financial Strain in a Post-Stimulus Era
As sticky inflation eats away at consumer spending power, coupled with the end of the global pandemic stimulus checks and child tax credits, credit card debt is at an all-time high. This is putting households in a position to lean on more leverage to afford increasingly expensive necessities such as gas, food, and rent.
As the charts below demonstrate, as of Q1 2023, household debt payments are claiming nearly 10% of disposable personal income compared to 13.2% during the mortgage crisis of 2007 (Source: J.P. Morgan). And with the still increasing interest rates by the Federal Reserve in March, credit card annual percentage rates, or APRs, will climb even higher. These rate increases could cost credit card borrowers an extra $3.4 billion in interest charges over the next 12 months (Source: WalletHub).
In another development, we are seeing an increase in auto and credit card loan delinquencies. As of Q4 2022, 5.9% of credit card balances, and 6.6% of auto loan holders are over 30 days delinquent (Source: J.P. Morgan).
While home prices are moderating in some places, median-priced single-family homes and condos were less affordable in the first quarter of 2023 compared to historical averages in 94% of counties across the nation – far above the 62% of counties that were historically less affordable in the first quarter of 2022 (Source: Attomdata.com).
Meanwhile, the commercial real estate market faces a glut of office space to which workers have not fully returned since the pandemic and about $270 billion in commercial real estate loans held by banks will come due in 2023 with roughly $80 billion, nearly a third, being office properties (Source: Trepp.com).
ROEHL & YI’S FINAL THOUGHTS
All signs show that economic challenges lie ahead, and mindfulness is required to navigate the choppy landscape.
Consider these suggestions:
- Move toward diversification and review asset allocation.
- Expect turbulence and stay disciplined.
- Be diligent with cash and take advantage of higher-yielding financial instruments.
- Remain defensive and cautious with your assets and reduce risk.
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This client newsletter is provided for informational purposes only. Nothing herein should be construed as the provision of personalized investment advice, nor should it be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change without prior notice. Third-party data sources contained herein are for illustrative purposes only, are believed to be reliable, but we take no responsibility as to their accuracy. The newsletter contains certain forward-looking statements that indicate future possibilities. Due to known and unknown risks, other uncertainties and factors, actual results may differ materially. As such, there is no guarantee that any views and opinions expressed herein will come to pass. Investing involves risk of loss including loss of principal. Past investment performance is not a guarantee or predictor of future investment performance.