April 2023

First Quarter Review of 2023

Putting Investments in Perspective

The first quarter of 2023 witnessed a slight drop in inflation, a rise in growth stocks and only slight increases in value stocks. This variance in performance is striking. When we look at the Nasdaq Composite, which is made up primarily of tech stocks, it was up 16.8% in the first quarter. The Dow Jones Industrial Average, which consists of 30 large company stocks from a variety of business sectors, was up only 0.4%. Like the Nasdaq the S&P 500 index did well with the large segment of large tech stocks in the average.

During this period, we have also seen bond prices moderate with value going up a bit, as interest rates went down slightly. The Federal Reserve is still controlling rates and has continued to increase the Fed Funds rate each time they have met.

Inverted Yield Curve

Generally, we would expect that the interest being paid to borrow money short-term would be less expensive than when borrowing for longer periods of time. This brings interest rates in line with a slopping upward curve where the interest being paid goes higher as you go further out in time. We refer to this as a normal yield curve.

There are occasions when the normal yield curve is not normal. This happens when short-term interest rates become higher than long-term interest rates. We refer to this as an inverted yield curve. An inverted yield curve is usually a precursor to a recession. We saw the yield curve become inverted in April of last year. It briefly moved back to normal, but for some time now, we have had an inverted yield curve.

At the end of the first quarter, the yield on the two-year U.S. Treasury was 4.06%. The ten-year U.S. Treasury, at the same time, was 3.49%. The duration risk on the ten-year bond is greater than the risk on the two-year bond. As an investor we are being paid more, currently, for investing for a shorter period, and the risk is less!

Is a Recession Imminent?

So, here it is. Since 1955 we’ve had nine recessions.  According to the San Francisco Fed, all nine have been preceded by an inverted yield curve. The time between an inverted yield curve and a recession has ranged from six to 24 months.

As mentioned earlier, as well as back in my April 2022 Newsletter, the inverted yield curve began in April of 2022. Will we have a recession? On Wednesday, April 5, 2023, The Wall Street Journal, in a headline in the Business & Finance Section, said “Shares Decline on Signs of Slowdown”. The lead of the article states: “Drops in job openings and manufacturing suggest economy is cooling off.” This is exactly what the Fed wants, as they believe such a slowdown will cool off inflation. The Fed is not going to be happy with a 4% or 5% inflation rate. Back in the 1970’s the Fed thought they had delt with inflation as it began to go down. Inflation then proceeded to go up dramatically.

Investing for Recession

As we should all know, there is no certainty in life. Will we have a recession? The probability is yes, but this may not be the case. Assuming the worst, how should we position our investments. Historically, the stock market goes down before a recession. It goes back up, before the recession is over. The stock market has been a leading indicator of where the economy is going. Currently, the stock market has been trading in a consistent range, moving up since March 13th, to the present. The Fed will have the biggest impact on what happens going forward.

Numbers Review

The S&P 500 index ended the quarter at 4109 compared with 3840 at year end, up 7.0%. The S&P Mid Cap index ended the quarter at 2512, up from 2430 at the end of the last quarter, or 3.4%. The S&P Small Cap index ended at 1182 compared with 1158 at the end of the last quarter, up 2.1%. The MSCI ex USA index for foreign stocks increased to 299 from 281, for a gain of 6.2%. The 10-year Treasury was 3.49% with an increase in value from 3.83% at the beginning of the year. The Bloomberg Barclays US Aggregate Bond Index yield went from 4.68%, at year end 2022, to 4.41%, for an increase in the value of corporate bonds year to date.

Looking Ahead

The FED has made it clear that they are going to do whatever is necessary to crush inflation. They also know that if the economy falters too badly it will be their fault. It seems likely that they will raise rates again, but we are now seeing a softening of the economy, a less serve shortage of workers, and large companies announcing major layoffs, to protect their earnings. At the same time, it appears that many stocks, especially growth stocks, are overvalued relative to earnings and earning potential. While value stocks, which outperformed growth in 2022, have not done well this year, they seem to be a safer investment and one that pays good dividends.

Conclusion

At this time, I am not straying from my position at the beginning of the year. It appears that having money in value stocks, some in growth and the use of short-term interest on cash is the way to go. As the year matures, a shift to bonds is likely from the short-term cash position. In addition, broader equity diversification by asset classes should once again become appropriate, in the future.

Ed Mallon

1 Markets Digest, Wall Street Journal, April 3, 2023 

2Business & Finance, Wall Street Journal, April 5, 2023 

3 Exchange, Wall Street Journal, April 1-2, 2023