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First Quarter 2023 Review and Outlook

As you’ve likely seen, there was plenty of drama driving the markets in the first quarter 2023, culminating in bank worries that sent volatility higher and stock prices lower. The headlines over the first three months of the year were beyond scary. They started with consensus among economists that recession was imminent. After better-than-expected economic reports, the narrative switched to higher-for-longer Fed policy. Then, if that wasn’t enough, March saw the second (and third) largest bank failures in U.S. history, completely re-shifting the outlook for interest rates going forward from higher-for-longer to perhaps cutting rates sooner rather than later. After two weeks of relative market chaos, coordinated efforts by regulators and the big banks to backstop the industry seemed to have calmed the markets.

Given those headlines, one might expect to be surprised that the S&P 500 gained 7.5% in Q1 with the Nasdaq Composite up even more. Bonds rallied as well. Cash was in the mix, with T-bills posting their biggest gain since Q2 2007 thanks to continued Fed rate hikes. It is important to note that while Q1 returns sound impressive, most stock market indices are still down significantly from their January 2022 peaks.

Going forward, the Fed is reaching a critical point in its battle against inflation, and the next couple of months will determine whether it can navigate a soft landing for the U.S. economy without tipping it into a recession. In recent months, the U.S. housing market has softened significantly, and manufacturing activity has dropped. In addition, the U.S. Treasury yield curve has been inverted since mid-2022, something that’s historically been seen as a strong recession indicator. In fact, the New York Fed’s recession model predicts a 54.5% chance of a U.S. recession sometime in the next 12 months.

So far, the most convincing argument a soft landing may still be possible has been the resilience of the U.S. labor market. The Labor Department reported that the U.S. economy added 311,000 jobs in the most recent February report, widely exceeding economists’ expectations. The unemployment rate rose a bit to 3.6%, but that’s still down from 3.8% a year ago.

So, will the second quarter bring relative calm rather than more big surprises? The likely answer is yes, as fears of a domino effect of failing banks have not yet come true, making investors more optimistic that perhaps the worst of the bank crisis may be over. Volatility has also receded while global equities resumed the uptrend that started last October. But given the current lack of an all-clear signal on the economic front, it would be premature to say that for sure.

*All data sourced from Ned Davis Research, Inc. as of 4/4/2023

Categories: The Market

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