The first quarter of 2023 featured plenty of drama in the markets, with the sudden failure of Silicon Valley Bank, the FDIC seizure of Signature Bank and the Swiss government’s forced feeding of the reeling, bleeding investment bank Credit Suisse to its main rival, UBS.  If you just looked at the headlines in the last several weeks, you would probably think the markets were being punished so far in 2023.  However, the opposite is true.  For the quarter, equity markets were higher around the world while bond prices rose as well.  Why?  While it is never possible to discern exactly how specific developments cause markets to move, it seems that investors are looking forward to a time later this year when the Federal Reserve goes into reverse and starts lowering interest rates.  Of course, for this to happen, inflation would have to subside and the economy would have to be showing significant weakness.

Inflation in Retreat

The most important issue in the markets now is how the Fed’s fight against inflation goes, and whether or not the tough medicine it is administering to the economy in the form of rapid interest rate hikes is having its intended effect.  For right now, it seems the medicine is working.  On Wednesday, the main measure of inflation, the Consumer Price Index (CPI) showed that inflation has now slowed for nine consecutive months from the 40-year highs reached in June 2022.  Headline CPI year-over-year dipped to 5% in March from 6% in February, the steepest month-over-month drop we have seen.  Consumers remain pessimistic, however, as these numbers reflect merely a slowing in the rate at which inflation is rising, not an actual decline in prices.  But because inflation measures such as the CPI measure conditions versus what they were a year ago, summertime is setting up easy comparisons with the inflation spike we saw last summer, making further drops in CPI likely.

Banking Crisis Helping Fed

Sudden failures of large banks are not on the list of what the Fed hopes to cause while it attacks inflation.  However, in our view, the government acted swiftly and effectively to contain what could have morphed into a much larger crisis and the net result of the Silicon Valley Bank fiasco is that banks will be more timid going forward, and less likely to extend the loans that keep our economy going.  Higher interest rates and risk-averse banks will result in lower loan volumes.  This is contractionary for the economy and should help the Fed press the lid down on prices.

Earnings Season Starting

Companies are beginning to report their first quarter earnings.  Broadly, earnings are expected to be lackluster, and we are about to enter an earnings recession, which is two consecutive quarters of earnings declines.  Earnings for the S&P 500 companies fell 4.6% in the fourth quarter of 2022 and are expected to drop 6.8% in the first quarter of 2023.  Estimates for the second quarter and the full year 2023 are trending lower as well.  Stocks, however, have held their gains for the year, despite the deteriorating earnings picture.  It seems that investors are looking across the valley of weakening corporate fundamentals to a recovery set to start once the Fed has prevailed in its fight against inflation and stops raising rates, or even starts lowering them.  With consumer spending slowing, corporate earnings dropping and capital spending tightening, the markets will have lots to contend with in the coming months before the Fed becomes a tailwind instead of a headwind.

As always, we are closely monitoring developments in the markets and are available to talk.  Please let us know if there is anything you would like to discuss about your portfolio or the markets, please call us at 619-319-0520 or email: thoms@orioncapitalmgmt.com