Uncertainty From The Fed & Recent Banking Woes
As part of the investment committee’s responsibility, our team is always tuned into the markets – whether during trading sessions or after hours reading, hoping to make sense of macro, micro, technical, fundamentals and everything in between. In the past two weeks this has intensified given what we saw in the banking sector with the failure of Silicon Valley Bank and other challenges. Add in this week’s Fed meeting and recent comments from Jerome Powell, there’s a lot to digest. Seeing that it’s been exactly two weeks since news broke of SVB’s issues (we covered it here), I wanted to try and make sense of what we’re seeing in the markets, our thoughts on the Fed, and how this all impacts your portfolios with us.
One of the themes we’ve been keyed on since the start of 2023 was that the economy, and specifically corporate earnings, were going to come under the microscope more so than the headlines of inflation and interest rates from 2022. Now to be fair, they are all interrelated, so even though the headlines last year were all about what the Fed would do next and inflation, the byproduct of higher rates was always slowing the economy and therefore lower earnings. I mean Jerome Powell said as much during most of his press conferences last year – something to the effect of trying to slow the economy, with the hope it would be a “soft landing” slow-down.
Market and interest rate expectations have shifted dramatically in the past two weeks. We saw the effects in both the stock and bond markets, without any real clear indication of what would happen next. The bond market showed signs of a Fed pivot and easing of financial conditions with how quickly rates declined. Some view this as a positive, meaning lower rates by the end of the year and a more forgiving Fed.
The stock market took the stance, immediately, that SVB collapsing, and the Fed’s subsequent backstopping of the banking sector would be good for stockholders. Help is on the way for banks, while the Fed would be forced to pivot sooner rather than later. Even though we had the 16th largest bank collapse in a matter of days, the Nasdaq increased by 4.5% the following week. That’s amazing when you step back and think about it. But this was an indication that the market expected lower rates, which would be helpful to “growth” stocks you see in the Nasdaq. This played out this week as well, until the market close on Wednesday when the market digested Powell’s comments.
It's hard to know what drives investor sentiment, but one thing is clear – the first signs of recessionary fears are on us with some of these bank issues. Yes, the Fed stepped in and helped save it from snowballing into something larger. But the impact and concerns remain. We will likely see a tightening of the credit markets, in some capacity at least, which could lead to a slowing economy.
Frankly, the market has been moving fast over the past two weeks. Both the stock market, the VIX (measure of volatility), and market expectations of what the Fed will do now and into the future. If we were hoping to gain any sense of clarity from the Fed this week, that unfortunately didn’t happen. While the markets continue to digest the news and statement from Jay Powell, here were some of our key takeaways from his commentary:
- They will be reactive, not proactive when it comes to the effect of the banking sector issues and the potential effects on the economy. They will adjust their path if they see negative outcomes from SVB and other banks but will not be adjusting before they see the data.
- The Fed’s base case is maybe one additional rate hike, with no further rate cuts through the end of 2023. However, the market disagrees and sees the potential for 2-3 cuts before year-end. This is why we're seeing a strong stock market and rates dropping for bonds.
Where does this leave us? Well, I think the biggest takeaway from the past two weeks is there is lots of uncertainty ahead. We continue to be cautiously optimistic but know we are not in the clear. While far from the banking crisis of 2007-2009, the current uncertainty could tighten credit markets, leading to a slowing economy. Is that reflected in last year’s bear market? Potentially. But we continue to think we could see short-term volatility until there is more clarity ahead.
As we’ve shared before, we shifted some of our equity portfolio last year and the beginning of this year to “quality” type companies – those with strong cash flow, solid balance sheets, and a proven record of profitability. We think they will do best during the uncertainty we may see ahead. We also added to our bond allocations at the end of 2022, and getting in when we did has proven beneficial.
Please don’t hesitate to reach out to our team with any questions.