The first quarter of 2023 saw a slow start for the markets, but they made a comeback in March. The US markets gained by low single digits, while the international markets showed modest gains. The developed markets’ performance was similar to that of the U.S., and the emerging markets fared slightly better. According to certain metrics, the Nasdaq moved into a bull market, and the S&P 500 and developed international markets performed well. Overall, the market’s strength at the beginning of the year exceeded expectations. However, whether this momentum will continue for the rest of the year remains uncertain. It’s crucial to examine the details closely.
Inflation Under Control?
The progress on inflation was the primary reason for the gains seen during the quarter. Although inflation is still high, it is significantly lower than where it began the year. The Fed’s fast-paced rate hikes have convinced markets that inflation will be under control, with the benchmark yield on the 10-year U.S. Treasury dropping significantly.
In March, the collapse of Silicon Valley Bank significantly impacted inflation, causing fear of a wider banking crisis that shook the markets. Fortunately, quick and significant federal actions were taken to resolve the immediate concern and stabilize the system. Banks were given access to capital to strengthen their balance sheets, which proved crucial in stabilizing the system.
However, these balance sheets remain weak, and banks are likely to pull back in the coming year, tightening financial conditions and doing much of the Fed’s job in controlling inflation. With that in place, markets now expect few, if any, rate hikes and very likely some cuts this year as the economy slows down.
Is Economic Slowdown Imminent?
Although an economic slowdown has yet to manifest, there are signs that it may happen soon. For instance, the March data was weaker overall, with a decline in job growth and consumer spending. Additionally, the rate hikes from last year are beginning to weigh down the economy, which is cause for concern. While a recession may occur by the end of the year, the good news is that if it materializes, it is likely to be mild in severity.
What Are the Risks?
While the overall outlook is positive, it’s important to acknowledge that there are still risks to the market. These include the evolving banking pullback and potential domestic and international political risks. In the U.S., the impending debt ceiling confrontation looms closer, while China’s actions remain unpredictable. The OPEC production cut is also contributing to uncertainty in the energy markets. Furthermore, we may not yet see risks, making it important to remain vigilant and prepared for any potential challenges.
Despite these risks, the fundamentals still appear healthy. Wider banking system disruption has been avoided, which is a big positive. Consumer confidence remains at healthy levels despite everything. So, as long as the job market stays strong, any recession (if we get one) should be mild.
The Big Picture
The current year has had positive and negative developments, but the overall balance is positive. This creates a favorable environment for further improvement in the coming months, despite the potential for negative events.
For instance, the resolution of the debt ceiling confrontation will clarify the economy’s status. Additionally, there is potential for further improvement in inflation and rates. Although risks remain, many of them can be overcome. The current situation is stable, although the possibility of future turbulence cannot be ruled out.
Investors should monitor the situation closely and be prepared for potential market volatility. It is important to have a diversified portfolio and not make rash decisions based on short-term market movements. It may also be wise to keep an eye on inflation, as it has the potential to impact markets and the economy in the coming months. As always, staying informed and seeking guidance from financial professionals when making investment decisions is important.