Commentary on the First Quarter of 2023
Stocks and Bonds Gain in Volatile First Quarter
In a quarter that saw the second largest bank failure in U.S. history and the ignition of full-scale banking crisis fears, the stock and bond markets both advanced, recording gains for the quarter. Bonds rallied as investors began to lower their expectations for inflation and economic growth this year as well as additional interest rate increases from the Federal Reserve (The Fed). The stock market rally was driven in large part by a handful of mega-cap technology companies. The following excerpt from a New York Times article written in mid-March amidst the banking crisis highlights this point well.
“On Monday, March 13, immediately after the government seized Silicon Valley Bank and Signature Bank, signs of panic were everywhere: Several regional banks suffered their worst day ever in the stock market, with First Republic Bank down more than 60 percent, in conditions so chaotic that trading in many individual stocks was halted as stock exchanges tried to limit the damage. Outside the stock market, government bond yields went haywire, oil prices slid and the dollar weakened, all showing that alarms about the economy were ringing on trading desks around the world. Yet the S&P 500 spent much of the day in positive territory, and it ended with a barely noticeable decline of 0.1 percent. Credit, again, goes to Microsoft and Apple, which both rose enough to counter a 15 percent decline in the entire regional banking sector that day. … It is phenomenal that two companies can direct so much power within the S&P 500.” 
One can see the effect this handful of mega-cap technology stocks has on index performance by comparing the returns of the market capitalization-weighted S&P 500 to the equal-weighted S&P 500 for March. The market capitalization-weighted S&P 500, whose performance is weighted to the largest market capitalization technology stocks, was up 3.5% whereas the equal-weighted S&P 500, whose performance is equally weighted to all 500 stocks regardless of size, was down 2.6%. By looking below the surface of the market, one can see the advance is not broad-based, but rather concentrated in a few sectors. The next test for the stock market may be to see if this narrow advance can broaden to the larger market.
Items to Watch
The Federal Reserve
The Fed continued to demonstrate its resolve to bring down inflation by raising interest rates by a quarter of one percent despite concerns about a banking crisis. The Fed has made it clear it believes the U.S. banking system is sound and well-capitalized, and it has the tools, if necessary, to alleviate liquidity pressures in the banking system. One recent example is the Bank Term Funding Program (BTFP) which was put in place by the Fed to provide additional funding to eligible depository institutions to meet the liquidity needs of their depositors. Market participants are now expecting the Fed to cease raising interest rates this spring and begin cutting them later this year. This expectation is not what the Fed has communicated to the market. Rather, the Fed sees rates staying elevated through this year before coming down in 2024. This expectation mismatch may lead to a spike in volatility if rates remain higher for longer.
The collapse of Silicon Valley Bank and Signature Bank led many to fear a run on the regional banks. Thankfully, this did not materialize en masse as government officials rushed to reassure depositors and put in place temporary lending facilities to alleviate liquidity pressures. The more lasting impact from this banking stress may be a tightening of lending standards, which would further restrict access to capital and could depress economic growth later this year.
Commercial Real Estate
Commercial real estate has come under pressure as interest rates have risen and occupancy rates have fallen, stemming from work from home and hybrid working models. A significant number of commercial real estate loans will need to be refinanced in the next 24 months, the majority of which are held by regional banks. If the economy were to experience a recession later this year or next, refinancing some of these loans could become more difficult, potentially further stressing the regional banks.
From the war in Ukraine, to the growing tensions between the U.S. and China, there are a multitude of geopolitical threats for an investor to worry about. One implication of this uncertainty is the reshoring of manufacturing capacity back to the U.S. from the far east. While U.S. companies will most certainly continue to have significant overseas operations, on margin, many companies will choose to diversify their operations to more friendly locations to make their supply chains more resilient. This, in turn, could lead to more persistent inflation.
The past 15 months have been very challenging for investors in the face of falling stock and bond prices. While the most recent quarter provided a welcome respite from this decline, we expect continued volatility as market participants wrestle with the possibility of further rate increases and assess the impact of past rate increases on the real economy in the coming months. We choose not to play the guessing game of what may occur in the future. Rather, our focus remains on building diversified portfolios comprised of financially strong companies to protect and grow your capital over time.
As always, we remain committed to helping you achieve your financial goals.
The opinions expressed are those of PYAW’s Investment Team. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Forward looking statements cannot be guaranteed.
PYA Waltman Capital, LLC (“PYAW”) is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about PYAW’s investment advisory services can be found in its Form ADV Part 2, which is available upon request. PYA-23-18