Q1 2023 Market Commentary
By Edward Miller, CFA®, CMT®
Following the worst year for US stocks since 2008, and the worst year for US bonds on record, 2023 has started off on an optimistic note with both stocks and bonds posting positive 1Q returns. The S&P 500 was up 7.5% and the Bloomberg Barclays US Aggregate Bond Index rose 3% in the quarter. Even non-US equities, which have underperformed US equities for more than ten years, participated in the gains as the MSCI All-Country World ex-USA Index returned an impressive 7% in the 1Q.
Notably, the major asset class that suffered negative returns in the 1Q was the best performing major asset class last year: commodities. The Bloomberg Commodity Index fell by -5.4% in the quarter, a decline primarily driven by the retreat in crude oil prices. Although the relatively high rate of inflation continues to be a key concern for investors, there are indications that pricing pressures are easing, as reflected by the drop in oil prices.
The 1Q could be characterized as a performance reversion quarter as many asset classes that did very well last year underperformed in the 1Q (such as commodities), and vice versa. In fact, the three worst performing equity sectors last year were Consumer Discretionary, Communication Services and Technology, and those three sectors were the best performing sectors in the 1Q. The new year saw investors become much more hopeful that inflation would continue to subside, allowing for the Fed to eventually halt further rate hikes, and higher beta stocks in these three sectors benefited from this rosy view.
In addition to a reversal of 2022 performance, the 1Q was also characterized by narrow leadership in many cap-weighted indices. For example, although the S&P 500 was up 7.5% in the quarter, 59% of the Index’s 1Q return was attributed to just four stocks, as shown in the following exhibit.
Equity returns from Apple, Microsoft, NVIDIA and Tesla comprised 4.39% of the 7.5% return for the S&P 500, or 59% of its quarterly return. To further highlight the extreme concentration of this performance, note that the equal-weighted S&P 500 (which weights each of the 500 stocks in the index equally) had a 1Q return of just 3.16%, or less than half the cap-weighted 7.5% return. When markets demonstrate such narrow leadership, it’s typically not a bullish or healthy sign; broad participation is much preferred!
Despite the positive 1Q, for approximately the past nine months the S&P 500 has returned about 0%, with the Index steadily rallying from the lows set last October to nearly matching its previous high established last August. As illustrated in the following chart, 4200 is a level that could prove to be difficult for the S&P 500 Index to successfully break through:
The elongated orange rectangle in the chart highlights an area that is often referred to as overhead resistance, which is a price level that appears to serve as a ceiling for further appreciation. Notice that on more than one occasion in the recent past, the S&P 500 has experienced trouble when attempting to get through this 4200 level. In a confirmed bull market, such overhead resistance usually does not pose a problem as investors are eager to buy, pushing prices higher as a result. But again referring to the above chart, since last June, the S&P 500 has tried on several occasions to get through this key level only to fail. When the Index has approached 4200, sellers have tended to outnumber buyers, ultimately forcing prices lower.
We believe that this overhead resistance will likely remain an obstacle until investors are able to gain more clarity on where the economy is headed, in addition to getting a better sense that the Fed is finished raising interest rates. As the following chart shows, there is a high (and increasing) probability that our economy will enter a recession in the near future.
The chart is from the Fed Reserve Bank of New York and it displays the probability of a US recession over the next 12 months as predicted by the Treasury yield curve. The blue shaded areas in the chart represent recessions. When this indicator has spiked higher in the past, meaning the probability of a recession occurring is increasing, more often than not a recession has indeed occurred. Currently this indicator has the probability of a recession in the next 12 months at 58%, the highest level since August 1982.
It's worth reminding that stock prices tend to discount the future and the S&P 500 Index has historically declined 6-12 months before the onset of a recession. With the Index down about -18% last year, one could argue that stocks have already discounted an eventual recession. However, while it would seem investors have anticipated a slowdown in the economy, the question they’re grappling with is the severity of the expected slowdown. Will we experience a fairly mild and short downturn in the economy (a so-called “soft landing”), or will the eventual recession become protracted and painful? If we experience the latter, perhaps stocks have further to fall as most investors could be caught off guard, having expected the former, less dismal scenario.
Our client portfolios have been positioned defensively since late 2021 and have remained so to date. We track a multitude of indicators to help inform our investment decision process and while several have turned bullish over the last several weeks, the net balance of our indicators continues to skew bearish. Until we discern more of a definitive bullish signal, we intend to maintain a defensive and cautious posture for client portfolios.
As always, if you have any questions, please feel free to call or email. The entire team at Measured Wealth wishes to thank you for entrusting us to deliver on your financial goals.
Ed Miller, CFA, CMT
Chief Investment Officer
Measured Wealth Private Client Group
Historical data is not a guarantee that any of the events described will occur or that any strategy will be successful. Past performance is not indicative of future results.
Returns citied above are from various sources including Factset, Bloomberg, Russell Associates, S&P Dow Jones, MSCI Inc., The St. Louis Federal Reserve and Y-Charts, Inc. The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. Investing involves risks, including possible loss of principal. Please consider the investment objectives, risks, charges, and expenses of any security carefully before investing.
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