After the large declines from 2022 in both the stock and bond markets, the first quarter of 2023 showed market gains across the board. US stocks rose 7%, developed country international almost 8%, and emerging markets international 3.5%.
With the 10-year Treasury interest rate declining from 3.88% at the end of 2022 to 3.48% on 3/31/23, bond prices – which move in the opposite direction of rates – rose in the 3-3.5% range for the quarter. This includes intermediate-term taxable bonds, inflation-protected bonds, and high-yield bonds.
These broad market gains have come against a backdrop of ongoing uncertainty in several areas.
US price increases continue to moderate, although more slowly than the Federal Reserve had hoped. Prices outside the US remain high as well.
The Fed raised rates again at the end of March, but by only 0.25%, due in large part to the turmoil in the banking industry. Probably the biggest question, for the US economy at least, is whether the Fed continues to raise rates this year, and if so by how much.
According to Nick Timiraos from The Wall Street Journal:
“Stubbornly high inflation and tight labor markets led Federal Reserve officials to signal they could raise interest rates at their next meeting despite a greater likelihood of a recession later this year.”
“The fallout from the failures of two midsize banks led Fed officials to consider skipping a rate increase at their meeting last month, but they concluded regulators had calmed stresses enough to justify a quarter-point rate rise, according to minutes of the March 21-22 gathering released Wednesday.”
There were two high profile bank failures in the US in early March, which the Fed and other government agencies addressed by providing short-term funding to the banks and guaranteeing deposits from bank customers.
Most of the assets of both failed banks were purchased by other banks, and no other failures have occurred since (although Schwab’s bank appeared to be in trouble for a couple of weeks; see our article, “Making Sense of the Recent Bank Failures”).
Bank issues in other parts of the world appear to be limited; the highest profile problem appears to have been resolved with UBS taking over Credit Suisse in Switzerland.
The WSJ article went on to report that “For the first time since officials began lifting rates a year ago, the Fed staff forecast presented at the meeting anticipated a recession would start later this year due to banking-sector turmoil, the meeting minutes said. Previously, the staff had judged a recession was roughly as likely to occur as not this year.”
Russia’s war in Ukraine continues, along with US-China tensions.
How the markets respond going forward will be determined by these and many other factors, some of which we already know about and others we don’t.
Two related stories from the past few weeks covered the impact of large technology companies on the broad stock market, and the question as to whether the Fed’s inflation target has been set artificially low.
The Impact of Large Tech Companies on the Stock Market
In the context of the 7% quarterly gain for the US stock market, the NASDAQ composite rose almost 17% for the quarter. The tech story, by Joe Rennison and Eli Murray of The New York Times, cited an even smaller set of companies as responsible for the gains:
“The fate of the S&P 500 index – used by investors as a barometer for the health of corporate America … – often comes down to just two companies: Apple and Microsoft … More than $15 trillion in assets … are linked to the performance of the S&P 500 in some way … with more than 10 cents of every dollar allocated to the broad index flowing through to Microsoft’s and Apple’s market valuations.”
The article also notes that the recent performance “cuts both ways. In 2022, the S&P 500 slumped close to 20%, a drop that would have been much smaller without the lousy performance of the tech sector. Apple and Microsoft together accounted for roughly one-fifth of the index’s total decline last year.”
The article cites artificial intelligence, which Microsoft has a huge investment in through ChatGPT, as a possible source of continued growth for tech. But whether that leads to further stock market gains remains to be seen.
Is the Fed’s Inflation Target Too Low?
On the Fed’s inflation target, Jeff Sommer of The New York Times wonders whether 2% is too low.
“It’s worth re-examining the 2% target: how the Fed arrived at it, whether it still makes sense, and whether current rules allow sufficient flexibility in decision making.
“Inflation needs to come down, unquestionably. But with the financial tightening already underway, inflation may wane in a sustained way in the next few months. At that point, the cost in lost jobs and economic growth could be cruel and excessive if the Fed tightens further in an attempt to drive inflation down to 2%, a target that is, after all, an arbitrary one.”
Sommer concludes that “the Fed should aim high [PPA note: meaning allow its target to rise to 3 or even 4% over time]. Inflation needs to come down, but if it means throwing a lot of people out of work this year, the Fed already has the flexibility to move slowly and mercifully. It may be wise to do so.”
Read “Market Gains Across the Board” in the Piedmont Exedra.