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M&R Capital Management 1Q 2023 Market Review

April 06, 2023

1Q 2023 Market Review

Dow Jones Industrial 33,482.72 +1.91%, S&P 500 4,105.02 +1.34%,

Nasdaq 12,087.96 +0.62%, US Ten Year 3.301%, West Texas Intermediate $80.53

The failure of Silicon Valley Bank (SVB) and Signature Bank (SBNY) ironically touched off a Fed-fueled rally in the final weeks of March. In the week beginning March 13th, the Fed flushed $154.3 billion into the banking system through each of its liquidity facility tools:

Source:  Board of Governors of the Federal Reserve System, Credit and Liquidity Programs and the Balance Sheet.  March 31, 2023

As the crisis eased at the end of last week the total provided by the Fed stood at a stunning $89.7 billion in support. While these levels of support don’t come close to the magnitude extended during the financial crisis of 2008-9, or even the levels in the Pandemic year 2020, they clearly have reversed much of the Quantitative Tightening of the preceding year, causing interest rates to drop significantly. In the days immediately preceding the failure of Silicon Valley Bank (SVB), the yield on the two-year Treasury note was 5.05%. By March 31st, that yield declined to 4.06%.     

The direct beneficiaries of this abrupt drop in yields were “long duration” growth stocks, particularly in technology and communications services, which vaulted 21.3% and 20.8% respectively in the first quarter. In these two categories strong performances were recorded by Alphabet, Amazon, Apple, Microsoft, Nvidia and Tesla. But most stocks in the other nine sectors comprising the S&P 500 Index turned in weak performances, and prices actually fell in four of the remaining nine sectors, led by declines in financials, energy, healthcare, and utilities, while real estate, industrials, and consumer staples recorded modest gains. Clearly, it was not a broad-based advance.    

An interesting look at periods when interest rates fell sharply due to an exogenous “shock” is provided by Enrique Abeyta of Empire Financial Research, below.  Abeyta examines five periods, including the Crash of 1987,  the collapse of UAL and the junk bond market in 1989, the aftermath of the September 11 attack, the Global Financial crisis of 2008-9, and the Pandemic Crash of 2020:

Notice the levels and performance of the S&P 500 from the date immediately preceding the shock or event until the subsequent market bottom. While the dates of these events are somewhat arbitrary, the implication is that we might have a bumpy ride ahead. But as Abeyta argues, it is important to distinguish “exogenous shocks” to an otherwise healthy economy, as occurred in 1987 and 2020, from shocks like the collapse of the financial system in 2008-9. It would seem that the current shock looks more like the events of 1987 and 2020, which were crises of confidence in an otherwise healthy economy. While unnerving, these sharp drops were contained in the span of a few months, as the Fed supplied ample liquidity to avoid the “contagion” spreading through the economy. It is early in the current crisis, but it seems that the Fed is successfully limiting the spread of the problem by its deposit guarantee of a relative handful of banks, and the generous extension of credit to many more institutions affected by deposit outflows.      

Perhaps a more difficult issue to address is the possible slowing in the extension of credit to regional and smaller banks, particularly for the commercial real estate industry. While Goldman Sachs projects a limited impact to bank earnings in 2023, an economy already slowing may be hard hit by a contraction in credit, as the cost of deposits rises for all but the largest banks.  While it does appear that inflation is slowing, we believe it may be premature to look for the Fed to “pivot” to rate cuts this year. It would seem that the banking crisis will not deter the Fed from yet another rate increase, particularly as current interest rates remain at or below the Fed’s favorite gauge of inflation, the Personal Consumption Expenditures Index or PCE. This currently stands at 5%. So, while the pop in the market averages just experienced is encouraging, we think that it is not yet time to abandon the defensive investment strategy described in our previous quarterly letter. But rest assured that the time will come again when owning quality stocks will be rewarding.