Q1 2023 - Market Review

ECONOMIC COMMENTARY

The equity markets overcame a slew of negative macro and fundamental developments and posted positive returns in the first quarter of 2023. In effect, equity investors seemed to be looking past the appalling trend in the ISM Manufacturing PMI most recent reading[1], lower IPO and merger activity, softening profit margins and earnings growth expectations[2] to conclude that the prospect of a near-term peak in interest rates was a catalyst for improving consumer and CEO sentiment, which would ultimately be conducive for long-duration assets, including equity markets. To be fair, investors are also likely looking past the shelter component measure of the US CPI (whose pitfalls we have highlighted before[3]) and assume that inflation is already much lower than the figure being reported. To be specific, the MSCI All Countries World Index[4], S&P 500 Index and the S&P TSX Composite advanced 7.02%, 7.36% and 4.55%, respectively, during the quarter.

Interestingly, excluding issuers who became takeover targets during the quarter, the best performers included a collection of ancillary cryptocurrency and artificial intelligence plays and some of the most significant large cap technology and consumer discretionary losers of yesteryear like Facebook (Meta), Tesla and Nvidia. The laggards, in contrast, were concentrated in the energy sector due to the decline in the price of crude oil and natural gas and, for reasons that we have already written about extensively earlier this month, the financial sector.

Interestingly, excluding issuers who became takeover targets during the quarter, the best performers included a collection of ancillary cryptocurrency and artificial intelligence as well as some of the most significant large cap technology and consumer discretionary losers of yesteryear like Facebook (Meta), Tesla and Nvidia. 

Fixed income markets rose in sympathy with equity markets as signs that higher rates were taking their toll on economy were multiplying, thereby sending bond yields lower across the curve. Movements in interest rate curves were particularly acute in the aftermath of the Silicon Valley Bank debacle as rates dropped by a record amount over a short period and implied volatility of interest rates, as proxied by the ICE Bank of America Merrill Lynch, surged to a record. While the US policy response, in particular the Federal Reserve’s Bank Term Funding Program (“BTFP”) was well perceived from a liquidity enhancing viewpoint, consensus is that the ongoing stress in the banking sector is leading to tighter lending conditions and the market’s response was to send credit spreads higher. Nevertheless, corporate bonds generally outperformed government bonds. To this point, the ICE Bank of America Global Government Bond Index and the ICE Bank of America Global Corporate Index returned 2,66% and 2,85% respectively. However, longer maturity bonds did much better than shorter maturity ones. 

At the time of writing this, deposits in the US commercial banking system were still flowing out albeit at a slower pace than they did earlier in March[5]. As such, it looks like the regulators did the right thing. That said, we find it ironic that the venture capital industry, which was the principal recipient of the over-investment and over-lending largesse of Silicon Valley Bank and the likes, did not contribute a penny to bail-in the fragile First Republic Bank[6]. For the moment, it appears that the risk of a credit crunch has been contained as capital evaporation seems to have been largely limited to the venture capital industry, SPAC and other highly speculative sectors. It would be arguably more worrying if capital disappeared from the hands of the capital providers themselves. That would be more difficult to contain.

[1] The University of Michigan indicator was at its lowest level since May 2020 at the end of February 2023.

[2] Source: FactSet

[3] https://patrimonica.com/rising-inflation-what-asset-owners-can-do-about-it/?lang=en

[4] Unless specified otherwise, index performance references total returns denominated in local currency terms.

[5] Source: Federal Reserve Bank of St-Louis, Weekly US Commercial Banks Deposits report.

[6] It was a consortium of banks led by JP Morgan that provided a 30 billion deposit backstop to First Republic Bank.