The first quarter of 2023 handed global investors much to digest. The year started with the erratic market performance of January and February, with the former witnessing broadly positive performance across most major asset classes and the latter generally the opposite. Then March’s banking system turmoil took center stage. By the time the quarter concluded, however, substantial gains had been generated for the breadth of the major global financial indices, despite lingering banking system concerns and a Federal Reserve (Fed) that reaffirmed its commitment to restoring price stability through a 25-basis point hike to the policy rate and hawkish near- term forward guidance. Across the equity markets, large cap companies, particularly growth-oriented, generated the most substantial total returns, while smaller cap and value-oriented companies struggled. Bond returns were overwhelmingly positive across both rate and credit-sensitive sectors, as interest rates declined sharply and credit risk premiums narrowed. Performance across real assets for the quarter appeared dispersed yet generally positive for the major asset categories excluding broad commodity indices, which faced headwinds of strong downward momentum across crude oil and natural gas spot prices.
Through the first two months of the year, financial market performance appeared somewhat balanced, with February’s broad-based weakness serving as a counterbalance to January’s strong showing. The events that unfolded across the U.S. banking system throughout March, however, dominated financial media headlines and conversation circles, as the failures of Silicon Valley Bank (SVB) and Signature Bank rekindled fears of contagion within the U.S. banking industry and broader financial markets. Across the pond, Credit Suisse’s longer-term operating struggles ended abruptly on March 19, with Swiss authorities forcing a merger with rival UBS.
As is often the case when the Fed seeks to tighten the monetary reigns, the most aggressive and over-levered players that were previously able to remain a going concern amid accommodative conditions remained exposed to higher interest rates. In the current Fed tightening campaign, SVB and Signature Bank appeared to be the first dominoes to fall, with others such as First Republic Bank and a number of regional banking institutions suffering through challenging operating conditions during the month.
Central to the growing unease across the banking industry was an increasing divergence between interest rates offered by banks to depositors versus yields available on ultra-short-term Treasury securities. Through March, for example, the national average rate on savings accounts stood at just 0.37%. In contrast, the yield on 1-month Treasury Bills was more than 400 basis points higher, with no associated credit or counterparty risk.
In a world dominated by banking access at one’s fingertips and an abundance of real-time financial media news flow, fundamental concerns about the soundness of an individual’s or institution’s liquidity increase the risk of a digital “run on the bank,” in which depositors flock to larger and presumably more financially sound banking institutions to safeguard their deposits. In the first quarter, U.S. commercial bank deposit liabilities declined nearly $500 billion, whereas total money market net assets increased $463 billion, according to Investment Company Institute data.
In the months ahead, investors are likely to tread through continued unsettling market conditions, with persistent inflationary and recessionary pressures coalescing with a hawkish Fed and the potential for further banking system strains. Prospects for additional monetary restraint in the face of inflation running uncomfortably above the Fed’s 2% target may result in further downside risks to the near and intermediate-term outlook, placing downward pressure on global risk premia and rewarding patient investors with an increasingly compelling investment opportunity set.
To conclude, while the first two months of 2023 offered investors a mixed performance picture across the major corners of financial markets, the failure of two major U.S. banking institutions and the forced merger between banking giants Credit Suisse and UBS demanded market participants’ attention in March.
INDICES
The Alerian MLP Index is a composite of the 50 most prominent energy Master Limited Partnerships that provides investors with an unbiased, comprehensive benchmark for this emerging asset class.
Bloomberg Fixed Income Indices is an index family comprised of the Bloomberg US Aggregate Index, Government/Corporate Bond Index, Mortgage-Backed Securities Index, and Asset-Backed Securities Index, Municipal Index, High-Yield Index, Commodity Index and others designed to represent the broad fixed income markets and sectors. On August 24, 2016, Bloomberg acquired these long-standing assets from Barclays Bank PLC. and on August 24, 2021, they were rebranded as the Bloomberg Fixed Income Indices. See https://www.bloomberg.com/markets/rates-bonds/bloomberg-fixed-income-indices for more information.
The CBOE Volatility Index (VIX) is an up-to-the-minute market estimate of expected volatility that is calculated by using real-time S&P 500 Index option bid/ask quotes. The Index uses nearby and second nearby options with at least eight days left to expiration and then weights them to yield a constant, 30-day measure of the expected volatility of the S&P 500 Index.
FTSE Real Estate Indices (NAREIT Index and EPRA/NAREIT Index) includes only those companies that meet minimum size, liquidity and free float criteria as set forth by FTSE and is meant as a broad representation of publicly traded real estate securities. Relevant real estate activities are defined as the ownership, disposure, and development of income-producing real estate. See https://www.ftserussell.com/index/category/real-estate for more information.
HFRI Monthly Indices (HFRI) are equally weighted performance indexes, compiled by Hedge Fund Research Inc. (HFX), and are used by numerous hedge fund managers as a benchmark for their own hedge funds. The HFRI are broken down into 37 different categories by strategy, including the HFRI Fund Weighted Composite, which accounts for over 2,000 funds listed on the internal HFR Database. The HFRI Fund of Funds Composite Index is an equal weighted, net of fee, index composed of approximately 800 fund- of- funds which report to HFR. See www.hedgefundresearch.com for more information on index construction.
J.P. Morgan’s Global Index Research group produces proprietary index products that track emerging markets, government debt, and corporate debt asset classes. Some of these indices include the JPMorgan Emerging Market Bond Plus Index, JPMorgan Emerging Market Local Plus Index, JPMorgan Global Bond Non-U.S. Index and JPMorgan Global Bond Non-U.S. Index. See www.jpmorgan.com for more information.
Merrill Lynch high yield indices measure the performance of securities that pay interest in cash and have a credit rating of below investment grade. Merrill Lynch uses a composite of Fitch Ratings, Moody’s and Standard and Poor’s credit ratings in selecting bonds for these indices. These ratings measure the risk that the bond issuer will fail to pay interest or to repay principal in full. See www.ml.com for more information.
Morgan Stanley Capital International – MSCI is a series of indices constructed by Morgan Stanley to help institutional investors benchmark their returns. There are a wide range of indices created by Morgan Stanley covering a multitude of developed and emerging economies and economic sectors. See www.morganstanley.com for more information.
The FTSE Nareit All Equity REITs Index is a free-float adjusted, market capitalization-weighted index of U.S. equity REITs.
Russell Investments rank U.S. common stocks from largest to smallest market capitalization at each annual reconstitution period (May 31). The primary Russell Indices are defined as follows: 1) the top 3,000 stocks become the Russell 3000 Index, 2) the largest 1,000 stocks become the Russell 1000 Index, 3) the smallest 800 stocks in the Russell 1000 Index become the Russell Midcap index, 4) the next 2,000 stocks become the Russell 2000 Index, 5) the smallest 1,000 in the Russell 2000 Index plus the next smallest 1,000 comprise the Russell Microcap Index, and 6) U.S. Equity REITs comprise the FTSE Nareit All Equity REIT Index. See www.russell.com for more information.
S&P 500 Index consists of 500 stocks chosen for market size, liquidity and industry group representation, among other factors by the S&P Index Committee, which is a team of analysts and economists at Standard and Poor’s. The S&P 500 is a market-value weighted index, which means each stock’s weight in the index is proportionate to its market value and is designed to be a leading indicator of U.S. equities, and meant to reflect the risk/return characteristics of the large cap universe. See www.standardandpoors.com for more information.
Information on any indices mentioned can be obtained either through your advisor or by written request to information@feg.com.
DISCLOSURES
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All data is as of March 31, 2023 unless otherwise noted.