Market Data for the Quarter Ending March 31, 2023:
- S&P 500 Stock Index: 4109, up 7.0%
- Ten-year Treasury Note Yield: 3.49%, down 0.39%
- Gold: $1,986 per ounce, up 8.9%
- Oil: $76 per barrel, down 5.4%
Both the S&P 500 and long-term Treasury bonds rallied sharply in the first quarter of 2023 on hopes that the Federal Reserve would end its campaign of monetary policy tightening and revert to cutting interest rates in the back half of the year. The strength in the S&P 500 was underpinned by an explosive rally in large “technology” stocks that are bizarrely seen by traders as a proxy for ultra-long-term Treasury bonds. The Nasdaq 100 index of such stocks rallied a whopping 20.5% versus a 0.4% gain for the more value-oriented Dow Jones Industrial Average, its largest outperformance since 2001 during the collapse of the “Dotcom” bubble. Gold rallied alongside Treasuries and tech stocks on hopes of Fed rate cuts, while oil declined in anticipation of slower economic growth due to the fallout from the collapse of Silicon Valley Bank (“SBV”) and two other small lenders.
By far the biggest risk to the S&P 500 moving forward is that the Federal Reserve does not ease monetary policy over the remainder of 2023, as traders anticipate. As the hope for Fed rate cuts was the rationale for the rally in tech stocks, their possible failure to materialize could lead to the rally’s undoing. The thinking behind traders’ hopes for rates cuts is that modestly moderating price inflation together with possibly weaker bank lending as a result of the SVB “crisis,” would allow the Federal Reserve to go back to doing what it does best: easing monetary policy. Such an outcome would lead to lower Treasury bond yields and higher tech stock prices because, as we alluded to earlier, traders think large tech stocks such as Apple and Amazon are essentially risk-free ultra-long-term bonds.
We are skeptical that the Fed will be able to aggressively cut interest rates this year because inflation is unlikely to fall quickly enough to allow it. Our view is that the economy will not sufficiently weaken to drive down inflation to the Fed’s 2% price target. (It stood at 5% as of February 2023.) We think it is unlikely that the failure of SVB will meaningfully reduce bank lending. Meanwhile, the rally in stocks and bonds will further stimulate economic activity, not restrict it. Taken in conjunction with continued job creation and wage growth, it is doubtful an economic recession is imminent. While such an outcome for growth and inflation would be a negative for large tech stocks, it would likely be beneficial for the value/income-oriented stocks in your portfolios because the fear of missing out (“FOMO”) on a speculative tech rally draws investment dollars away from said income-value stocks, thus depressing their prices.
The other significant risk facing stocks over the remainder of the year is the debt ceiling standoff between the Biden Administration and House Republicans, which we expect to take place sometime during the third quarter of this year. For those of you who are unfamiliar with the debt ceiling, US law stipulates that value of outstanding Federal debt be capped below a specific level. Accordingly, Congress must routinely raise the statutory debt limit to allow the Treasury to continue to borrow to repay maturing debts and fund the operation of the US Government. A failure to raise the debt ceiling could lead to a default on the US national debt, an epic financial crash, and an economic depression. House Republicans see this as an opportunity to force the Biden Administration into making drastic spending cuts that will harm the economy, thus improving their odds in the upcoming 2024 elections. They attempted such a stunt in 2011, which although ultimately resolved, led to a 17% fall in the S&P 500 over ten days and a credit rating downgrade of US Treasuries.
This time around, the attitude of traders seems to be that given the experience of 2011, House Republicans are merely bluffing so their shenanigans can safely be ignored. However, if a definite “deadline” to raise the ceiling comes into view and the basis of a resolution is not apparent, some traders may begin to panic sending stock prices lower. Our view is that the Republicans are probably bluffing because a financial panic and economic depression are not in the interests of their wealthy donors, and money talks. Even so, one cannot be certain given the strained state of American politics.
Considering the risks cited above, we see the S&P 500 trading in a range of 3600 to 4300. Given the relatively higher-quality and lower valuations of your portfolio holdings, we would expect them to hold up better than the broad market in an adverse scenario just as they did during the steep market declines of 2002, 2008, and 2022.
As always, we appreciate the confidence you have invested in us with your business, and please do not hesitate to contact us if you have any questions regarding your investments.