This blog serves as a follow up to our previously released Q1 Investment Themes, as well as an update on what we are seeing and our current outlook.
Here are the top three things we are covering in this month’s quarterly update:
- The regional bank crisis dominated headlines in March and sent the Fed, Treasury, FDIC and politicians into action to prevent a systemic panic.[1]
- Inflation continues to impact U.S. and global consumers. The Fed, despite the regional bank crises, hiked rates again.[2] The absolute level of inflation, which is the actual prices of goods and not just the rate of change in prices, is creating a huge problem for households all over America.[3]
- Economic growth, as indicated by GDP, is likely going to show negative numbers in the first quarter of 2023. The negative GDP numbers will probably persist into the second quarter, and even the third quarter. If more new issues pop up in the banking sector, or the longer inflation bites into consumers, the more likely the economy stays in a recession for much of 2023.
Market
The Nasdaq dramatically outperformed the S&P 500 during the quarter as traders sought the “safety” of big-cap tech stocks. The Nasdaq finished up 16.77% for the quarter. The S&P 500, which is somewhat influenced by these tech stocks finished up 7.03% for the quarter. The Dow Jones which is more industrial, underperformed the S&P 500 and finished up 1.83% for the quarter. The RUT finished up 2.34% for the quarter.[4]
The World Index (MSCI) nearly matched the S&P 500 during the quarter ending up 7.25%. Emerging Markets trailed that, ending up 3.55% on the quarter.[5]
We’ve seen commodities, which did well during the high inflation in 2022, start to tail off as we’ve seen inflation recede. With challenging economic data, when we go into a recession, we typically see lower demand and pricing pressure occurs. Commodities finished down -6.47% for the quarter.[6]
Gold outperformed as the value of the dollar came down. When we see a banking crisis or major concern, we typically see good performance in gold. Gold was flat going into March but finished up 8.76% for the quarter.[7]
With bonds we’ve seen a big difference in the start of 2023 as compared to last year. There’s been a reversal in interest rates which has cause the pricing of bonds to do better overall. When the banking crisis kicked off, we saw a reversal in the two-year rates and are now down closer to the 4% level, finishing the quarter at 4.06%. The Ten-year yield (TNX) finished the first quarter at 3.48%.[8]
Oil prices trended similarly to commodities and finished the quarter down -9.09%. Just recently, OPEC announced a surprise cut to their production levels (https://www.cnbc.com/2023/04/03/oil-opec-just-made-the-feds-job-more-complicated-heres-what-they-did.html). This has caused the price of oil to increase to start the quarter.[9]
Economy
The big headline of this last quarter was the regional banking crisis. This was the largest increase in bank failures since 2008, and one of the largest ever as well. We had pretty much avoided any bank failures since about 2013 and some believe we’re not necessarily done with this banking crisis yet. [10]
The two banks that failed in March, Signature Bank and Silicon Valley Bank, had some of the riskiest depositor banks, meaning that they had a significant amount of their depositor base having over $250,000 of deposit balance in the bank, which left them very susceptible to higher money market rates. Quick movement of depositors out of the bank in early March led to the balance sheet imbalances that they had.
Another big concern we have on the horizon with regional banks is commercial real estate loans. Many of the commercial real estate loans were originated in regional and smaller banks and a significant amount of those loans are maturing over the next two years and they’re going to have to be refinanced or paid off.[11] We’ve seen vacancy rates since COVID dramatically increase and stay really high[12]. This creates a huge risk that these owners of commercial real estate with these large loans are not going to be receiving enough in rents to cover the cost of those loans, which could create a significant challenge ahead for regional banks.
Other data out there giving us some concern is GDP. We anticipate seeing over the next couple quarters, negative to flat quarter over quarter growth in GDP.[13] This slowing growth will put more stain on the overall economy. We do also see inflation coming down but will still remain higher at around 4%.[14] This is higher we have experienced in the past pre-Covid and higher than the Fed’s mandate. The recent spike in oil prices, we aren’t likely to see any relief in gas prices at the pump in the short term.
When looking at the consumer, even with salaries increasing, real earnings growth has been negative over the last two years with inflation out pacing this growth.[15] This negative growth has caused strain onto people’s way of living which has led to a significant rise in credit card balances over the last year. The increased balances combined with a significant increase in credit card interest rates has made for a larger amount of total payments being needed to pay off their credit card.[16] When looking at housing, even with the slowing of price increases, with interest rates up so much, the affordability of housing is at one of the worst places we’ve seen in a long time.[17]
We are also starting to see some constraints in the labor markets. Layoffs are increasing slowly and steadily not only in small business but also in tech sector.[18] With the number of openings out there, these individuals may have been able to find jobs relatively quickly and not be reflected in the unemployment levels. As we are see jobs openings decrease, with more potential layoffs, it does give us cause for concern for what may be coming.
While the economy has remained steady through Q1, we are starting to see data points that are giving us cause for concern whether its commercial real estate or corporate debt space. If we don’t rates go down, between corporate and commercial credit, there is a lot of strain coming at a time when we see worsening economic data.
Summary
- The regional bank crisis dominated headlines in March and sent the Fed, Treasury, FDIC and politicians into action to prevent a systemic panic.
- Inflation continues to impact U.S. and global consumers. The Fed, despite the regional bank crises, hiked rates again. The absolute level of inflation, which is the actual prices of goods and not just the rate of change in prices, is creating a huge problem for households all over America.
- Economic growth, as indicated by GDP, is likely going to show negative numbers in the first quarter of 2023. The negative GDP numbers will probably persist into the second quarter, and even the third quarter. If more new issues pop up in the banking sector, or the longer inflation bites into consumers, the more likely the economy stays in a recession for much of 2023.
We hope you have enjoyed getting a deeper look into our investment research and look forward to providing this to you each quarter going forward. Thank you from the entire Konvergent Team!
[1] https://www.cnbc.com/2023/03/12/regulators-unveil-plan-to-stem-damage-from-svb-collapse.html
[2] https://www.cnbc.com/2023/03/22/fed-announces-interest-rate-hike-of-25-basis-points.html
[3] https://www.yahoo.com/now/inflation-wreaking-havoc-american-middle-120000044.html
[4] Slide – Major Index
[5] Slide – Global vs Emerging Market
[6] Slide – Commodities
[7] Slide – Precious Metals
[8] Slide – 2-Year & 10-Year Treasury Rate
[9] Slide – WTI Oil Price Change
[10] Slide – Total Assets & Exposures of Failed Banks
[11] Slide – Commercial Real Estate Lending
[12] Slide – Commercial Vacancy
[13] Slide – GDP QoQ
[14] Slide – CPI YoY
[15] Slide – Real Earnings Growth
[16] Slide – Consumer Credit
[17] Slide – Housing Affordability
[18] Slide – Small Business Employment & Tech Layoffs