Q1 2023 Perspective: Positive Returns, 563 Banks, The Fed and the Dollar

Summary video: click here (5 minutes)

The first quarter of 2023 ushered in positive performance in both the equity and bond markets, despite some fireworks courtesy of Silicon Valley Bank. Inflation calmed significantly, signaling that price spikes have been mitigated. Q1 also marked the one year anniversary of the ongoing Ukraine War and the long-awaited end of COVID lockdowns and restrictions across the globe. During a noisy quarter, every major asset class increased for the second quarter in a row. Please read that again, as pundits across the spectrum would lead you to believe the exact opposite. Yet again, the importance of disciplined financial planning and investing are rewarded, while the perils of prognostication hinder progress. Last year, we wrote that difficult markets are when the majority of wealth is earned…you just don’t realize it at the time. As evidenced by the last two quarters, markets can climb a wall of worry - producing positive returns, when it feels like they shouldn’t. In markets and economies, this is typical of leading indicators, including capital markets.

Our core themes for 2023 are driving the direction and outcomes so far: fixed income markets, the Fed and inflation, the dollar and digitization of currency, and the never ending economic tug of war. Let’s review the relative data points in context:

Stocks and bonds ended in positive territory for the second straight quarter.

• International Stocks (MSCI ex US Index): +7.58% Q1
• U.S. Stocks (Russell 3000): +7.18% Q1
• Emerging Market Stocks (MSCI Emerging Index): +3.94% Q1
• U.S. Bonds (Bloomberg Barclays Aggregate Index): +2.96% Q1
• U.S. Small Cap Stocks (Russell 2000): +2.74% Q1

After a difficult 2020, bond prices have rebounded, and we view the glass as half full (if not more) with rates remaining in the 4-5% range.When rates go up, bond prices go down. As a result, bond prices went down across the board last year, though to dramatically varying degrees. Prices and yields all depend on the length of the bond. Those that stayed with relatively short term bonds (as we do), reinvest their interest at the higher rate of 4-5% more quickly to take advantage of new opportunities. Those locked in to long term bonds do not have that opportunity. The nerd alert term for this approach is ‘bond immunization’ (stay tuned for more detailed article). Investors, companies, and banks should keep bond maturities in line with future cash needs. If you do that, interest rate hikes help over time! Silicon Valley Bank failed, in part, because they had long term bonds with short term depositor needs. Which brings us to…

563 banks have failed since 2001. That’s 25 per year. The bank turmoil in Q1 was relatively isolated, as the fear-mongering, 2008 comparisons were downright irresponsible. Banks fail when they are poorly run. Silicon Valley Bank was poorly run, and it failed. This was not a bank failure indicative of a broader risk in the banking system. We published an article (click HERE to review) in March as a reminder about FDIC limits and the speed with which depositors will be made whole in the event of a bank failure. Any concerns about the limits can be mitigated with simple and accessible strategies.

The Fed’s fight to calm inflation is working, though it remains above the 2% Fed target, and likely will (and should) for some time. Economics is the ‘dismal’ science, because there are never black and white answers. As such, inflation is not the effect of one specific cause. Rather, money supply, consumer behavior, supply chains, and employment all play a role. COVID resulted in the perfect inflation storm, affecting all of these. Fortunately, there is good news on inflation! Supply chains continue to improve, the money supply shrunk for the first time in nearly a century, consumer spending mix normalized, and the labor force returned to pre-pandemic levels. The historical average since 1960 is 3.68%, and we’re gradually reverting towards that number. Let’s take a step back, acknowledge progress, and root for goldilocks inflation - not too high, not too low.

Real GDP (Gross Domestic Product) for Q1 is estimated at 2.5%, as of April 14th. Real GDI (Gross Domestic Income) and other measures of output are also positive for the quarter. We were not in a recession in Q1, despite the recession and ‘everything is broken’ noise reverberating at a high decibel level. There is always a tug of war. Inflation is decreasing, yet remains higher than target levels, the Fed will likely hike rates again this year, and corporate earnings expectations are lower. On the other hand, trade volume is at an all time high (despite protectionist rhetoric), unemployment and the labor force are historically strong, and the IMF projects positive global growth in 2023, and even higher in 2024. As always, the economy represents a multitude of inputs, positive and negative, but Q1 is poised to show growth.

The dollar remains relatively strong, albeit not as strong as a year ago. I want to reiterate a point from last quarter: International finance is relative. Don’t fall for the politics around “strong” and “weak” when it comes to the dollar. If the dollar weakens in 2023, the result for the US economy can be good. Part of the GDP equation is net exports (exports minus imports). If the dollar is weaker relative to other currencies, other countries can buy more U.S. goods, driving more exports and adding to GDP. In fact, more exports and higher GDP will help the debt to GDP equation, which has already improved by nearly 10% in a short period of time.

Managing your financial plan starts with controlling all of the things we can. Beyond that, our process revolves around data, discipline, and diversification. This is the best opportunity to capture returns like those realized in the past six months! We don’t have a crystal ball - no one does. So, watch the news with a counterbalance, or better yet, turn it off, and enjoy the beautiful spring weather!

Sources: 2023 Index Returns dimensional.com, USA Today “How Often Do U.S. Banks Collapse”, wsj.com The Dow Just Notched Its Best Month Since 1976 11-1-2021, Federal Reserve Board of Atlanta GDPNOW 4-12-2023, BLS.gov, FRED.com M2 Money Supply, FRED.com US Debt to GDP

This material represents an assessment of the market and economic environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Past performance does not guarantee future results. Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.

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Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices do not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.

Index Definitions:

The Consumer Price Index (CPI) is a measure of inflation compiled by the US Bureau of Labor Studies.

Barclays U.S. Aggregate Bond Index: The Bloomberg Barclays U.S. Aggregate Bond Index is an unmanaged index of fixed rate debt securities rated investment grade or higher by Moody’s, Standard & Poor’s, or Fitch rating services. All issues in the index have at least one year to maturity and an outstanding par value of at least $25 million to $1 billion based on the type of security. Indices are not available for direct investment and do not reflect any fees that may be charged.

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The Russell 2000 index is an unmanaged index of the 2000 smallest companies in the Russell 3000 index. The Russell 2000 Index is used as a representative sample of the small companies in the United States economy. The Russell 2000 index consists of only stock holdings. Indices are not available for direct investment and do not reflect any fees that may be charged.

The Russell 3000 index is an unmanaged index of 3000 companies in the United States. The Russell 3000 Index is used as a representative sample of the United States economy. The Russell 3000 index consists of only stock holdings. Indices are not available for direct investment and do not reflect any fees that may be charged.

DJIA: The Dow Jones Industrial Average is an unmanaged index of 30 companies used as a representative sample of the United States economy. The DJIA index consists of only stock holdings. Indices are not available for direct investment and do not reflect any fees that may be charged.

Nasdaq Composite Index: The Nasdaq Composite Index is a market capitalization-weighted index of more than 3,700 stocks listed on the Nasdaq stock exchange. The Nasdaq Index is heavily weighted toward the technology sector and consists of only stock holdings. Indices are not available for direct investment and do not reflect any fees that may be charged.

[1] Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.

[2] Investments in emerging markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.