First Quarter Recap: The S&P 500 Starts the Year with Gains Despite Continued Uncertainty.
Markets showed strong gains in January, driven by decline in inflation indicators. That and surprisingly resilient economic data combined to increase investors’ hopes the Fed could deliver an economic soft landing, where the economy slows but avoids a painful recession while inflation moves closer to the Fed’s target. Additionally, corporate earnings for the fourth quarter of 2022 (reported in January) were “better than feared” and the resilient nature of corporate America contributed to the growing hope that both a recession could be avoided. The S&P 500 posted strong gains in the month of January, rising more than 6%.
In February, optimism for an economic soft landing was set back. January’s jobs report (released in early February) showed a massive gain in jobs, implying the labor market will remain tight (something the Fed believes is contributing to inflation). Then inflation metrics such as CPI and the Core PCE Price Index showed minimal price declines, implying the drop in inflation was ending. These factors led investors to price in higher interest rates in the coming months, and that weighed on stocks and bonds in February. The S&P 500 finished with a modest loss on the month, falling just over 2%.
March began with investors still focused on inflation and potential interest rate hikes, but the failure of Silicon Valley Bank shifted investor focus. When Signature Bank of New York failed just days later, concerns about a regional banking crisis surged. In response, the Federal Reserve and the Treasury Department created new lending programs to shore up regional banks and prevent bank runs but concerns about the health of the financial system persisted and those fears weighed on markets. However, while the Federal Reserve hiked interest rates again at the March meeting, policy makers signaled they are close to ending rate hikes. That admission, combined with no additional bank failures, eased concerns about a banking crisis, and the S&P 500 was able to rally during the final two weeks of March to finish the month with a small gain.
Second Quarter Market Outlook
Markets begin the new quarter facing many sources of uncertainty including inflation, future economic growth, remaining Fed rate hikes, and whether the regional banking crisis is truly contained. Despite this, markets proved resilient over the past six months since hitting their lows in October 2022. So, while headwinds remain and markets will likely be volatile, a path for future positive returns remains.
Starting with banks, important differences exist between what happened in March and the 2007-2008 financial crisis and regulators have demonstrated their commitment to avoid a repeat of those difficult days. As we begin the new quarter, there is reason to hope the crisis has been contained. Whether that proves true, regulators and government officials have shown willingness to use current tools (or create new ones) to prevent a spread of the regional banking crisis, and that’s an important, and positive, difference from 2008.
Inflation remains a major longer-term influence on the markets and the economy, and its continued decline this quarter will be important for investors and the markets. If inflation declines, that should provide a powerful tailwind for both stocks and bonds.
Regarding economic growth, markets rallied on the hope of an economic soft landing earlier in the first quarter, and while the regional banking crisis complicates that optimistic outlook, it is still possible. To that point, employment, consumer spending and broad economic growth have remained impressively resilient, so while we should expect some slowing in the economy this quarter, a recession is by no means guaranteed. And a soft landing would be a material positive for risk assets. Finally, after an intense interest rate hike campaign, the Fed signaled it is close to being done with increases, and that would remove a material economic headwind. If that expectation continues, it increases likelihood the economy can achieve the desired soft landing.
Still we are prepared for continued volatility and focused both on managing risks and return potential. We understand a well-planned, long-term-focused, and diversified financial plan can withstand market surprises and related bouts of volatility, including bank failures, multi-decade highs in inflation, high interest rates, geopolitical tensions, and risks of recession.