- The S&P 500 was up in March despite the collapse of Silicon Valley Bank, the second largest banking failure in U.S. history.
- Earlier in the month, Fed Chair Jerome Powell testified before the Senate and House explaining how inflation was still uncomfortably high and that the Fed will likely be forced to raise rates higher than previously thought. This pushed the 2yr Treasury above 5% and the 10yr Treasury over 4%.
- Then came the failure of Silicon Valley Bank (SVB), Signature Bank and Silvergate Bank. As well as a deal to save Credit Suisse overseas. We’ll spare you the discussion on why this happened, but the news sent shock waves through the financial system as the 2008 financial crisis is still burned into investors’ minds.
- The FDIC, Treasury and Fed acted swiftly and issued a statement that they were stepping in to protect all depositors of SVB and Signature Bank. They also created the Bank Term Funding Program in addition to the pre-existing discount window to provide additional liquidity.
- The recent events in the banking sector will likely lead to further tightening of bank lending standards, which could further slow growth and make it even more difficult to avoid a recession. The bond market immediately recognized this risk and is now pricing in the Fed cutting interest rates later this year. The 2yr Treasury dropped to a low of 3.75% and the 10yr to 3.4%.
- However, the stock market seems to be dismissing the increased risk of a recession and is cheering the fall in interest rates. Interest sensitive sectors such as technology are up big this year, with the Nasdaq up 6.8% in March vs a drop of –4.8% in small caps.
- The Fed decided to raise rates by 0.25% to a range of 4.75% - 5%. Powell acknowledged the recent banking issues and that it may lead to tighter monetary policy. However, he reinforced that their priority is to bring inflation down and that all future moves will be data dependent. The Fed updated their projections showing they anticipate one more rate hike this year.
Why It Could Keep Going Higher
- The primary driver of U.S. economic growth is the U.S consumer and Americans still have excess savings they are able to spend.
- Employment is still strong and that has always begun to slip before a recession.
- Inflation continues to decelerate and the Fed may be close to pausing rate hikes.
- The S&P 500 has fallen to a much more attractive valuation, significantly improving the future return potential.
- Inflation and the Fed’s response to get it under control are still the biggest risks the economy faces currently. Fed policy impacts the economy with a significant lag so it is hard to determine what the future effects will be from the current rate hikes.
- Most foreign central banks are tightening policy at the same time, which may further amplify a global contraction.
- Employers may be forced to lay off more of their labor force to maintain margins in a slowing economy.
- Further Geopolitical tensions.
- JOLTs data showed that job openings fell by 410k and the quits rate fell to its lowest level since May 2021.
- Nonfarm payrolls increased by 311k in February and unemployment ticked up to 3.6%. Also, the participation rate increased and wage growth moderated.
- CPI was up 6% year over year in February, in-line with expectations.
- PPI fell 0.1% beating expectations of a 0.3% gain.
- U.S. Existing Home Sales jumped 14.5% in February, ending a streak of 12 consecutive declines.
- The ISM Manufacturing PMI sank deeper into contraction at 46.3.
- The Bank of Canada paused it rate hikes after eighth straight increases.
- February retail sales fell by 0.4% for the month, following a revised 3.2% gain in January.
- ECB raised rates by 50 bps and signaled it was ready to supply liquidity to banks if needed.
What We Are Doing
The recent fallout in the banking system hasn’t changed our overall outlook much. We still believe that the stock market is not correctly pricing in the continued pressure on earnings that most companies will be faced with over the next several quarters. We used the stock rally in March to further underweight equities with an overall defensive tilt.
The banking issues will likely lead to tightening of credit, especially hurting small/mid-size businesses. We moved some of our small cap exposure to large caps during the month. We also reduced some of our value overweight. We have maintained an overweight to alternatives and added some Gold to the portfolios.
We will continue to watch the economic dynamic carefully to take advantage of opportunities as they present themselves.
If you would like us to review your existing portfolio or discuss where to allocate capital in today’s market, please visit www.TalkToFreedom.com to schedule a call.