Strategy and Positioning written by Steve Orr, Chief Investment Officer; and Essential Economics written by Mark Frears, Investment Advisor

As of market close March 31, 2023. Returns in percent.

Investment Insights

 — Steve Orr 

Okay, okay

We are writing this midday Friday. Check out the year-to-date and March returns for all asset classes in the above table. Most every asset class finished in the green despite multiple wars, floods, bank failures and, of course, the looming Most Anticipated Recession Ever. The S&P 500’s rally off the October lows still appears to us a countertrend rally inside of an ongoing Bear cycle. Most of the positive price action the last two weeks of March was driven by the mega-tech stocks like Intel (+23%), NVIDIA (+18%) and Netflix (+16%). Overall trading volume is weak, and most sectors are only marginally higher. 

March’s returns were hampered by bank liquidity fears after the collapse of Silicon Valley and Signature banks. Mid and Small cap indices fell -5% and 7% in the month, thanks to traders dumping small bank stocks. The Bloomberg small-cap regional bank index fell 35% during the month. We would note that the withdrawal of deposits from smaller banks is not a solvency issue. The vast majority of banks in the U.S. are on much better footing than in 2008. 

A modest one-quarter to one-half drop in Treasury yields masks one of the wildest rate swings in our memory. And we do have a memory. From peak to trough in March, the two-year Treasury moved 1.3%, the most in over thirty years. The swings in rates in the early 1980s were larger, but remember the yields were in the 9% to 11% range, triple today’s levels.  Further out the yield curve, 10-year Treasury notes were not quite as volatile, but still ended a half-percent lower. The near 1% collapse in the two-year yield in March raised the inverted yield curve spread to 10-year Treasuries by half, from -107 basis points to -56bp (or just over one-half a percent). The Treasury curve is still saying that the Fed has gone too far and forward growth will be below trend. Two quarter-point rate increases last quarter and possibly one more in May place us in the camp that says the Fed is about done. 

Overall, an okay quarter for headline index returns, but not enough to declare the Bear cycle over. Breadth measures such as the number of stocks above their 200-day moving average and New Highs minus New Lows are below average versus the last five years. As mentioned earlier, volume remains lackluster. BofA reports that this past quarter investors added just over $500 billion to cash. The last time that happened was in the spring of 2020. Except for a double bottom pause in September and October, the rest of 2020 was a ripping rally for stocks. 

Why and how

Disintermediation, the five-dollar word for pulling money from banks, happened back in the 1970s at the invention of money market funds and in the 1980s, when Savings and Loans were granted deposit insurance. This time around, the Fed raised interest rates very quickly over the last 12 months. The Fed’s strategy was and is to raise rates high enough to choke off job growth, which should lower inflation. 

Money market funds jumped on the higher rate train by utilizing the Fed’s Reverse Repo Facility. This program pays a nightly interest rate close to money market funds and banks that place money at the Fed. Its original intent was to put a floor under very low interest rates. It is likely the Fed did not anticipate the rush of money market funds to the RRF. The Fed’s tactic to support interest rates drained money out of the banking system. Lower deposits at banks mean less money to lend, which in turn means less capital expansion and hiring. We think the effect of this drain amounts to an additional interest rate increase of at least 1%. 

Status check

Fourth quarter 2022 GDP was revised down one-tenth of a percent to 2.6% last week. While not a big move, it masked the fact that corporate earnings fell at a -18% rate for the second quarter in a row. Consumer spending was flat and most of the gain was in inventories. Inventories will get sold someday, and sometimes at a steep discount. The Atlanta Fed’s GDP tracker projects the first quarter GDP level to be 2.5%. This would be impressive if it comes to pass.  

Markets care about what comes next, and GDP numbers are rearview mirror stuff. Current surveys like the Dallas and other regional Fed banks show declining activity. Texas manufacturing and services outlooks continue to deteriorate. The Texas services employment index fell into contraction for the first time since July 2020 last month. Every economic indicator in our dashboard is some shade of red. After housing, crypto, manufacturing slowdowns and bank failures, we are a bit mystified as to why the Fed needs more rate increases. 

April blooms?

Our trusty Stock Trader’s Almanac tells us that April is the #1 month of the year for the Dow Industrials since 1950 and #2 for the S&P 500. Both have averaged +3% or better gains. The current fundamental picture is still okay — but we think it is turning from okay to blah. Job gains for March should be reported this Friday at around 210,000 and the unemployment rate at 3.6%. Jobless claims remain very low. 

Speaking of jobs, companies are required under certain conditions to file Worker Adjustment and Retraining Notices with their state employment agencies. Last year’s Texas numbers through mid-March were approximately 1,300. This year, north of 7,000. California, 6,500 last year; this year, over 28,000. Granted, many of those are tech jobs, but you should expect jobless claims to rise this summer. Stats like these are why our indicators are not more positive.