Stress Tests
In the first quarter there were numerous anxiety inducing factors for individuals and institutions to incorporate into their investing calculus. As the quarter began markets looked through the restrictive monetary policy of the Federal Reserve to the prospect of a soft landing for the economy and a reversal of rate increases that were the cornerstone of the Fed’s effort to reduce inflation. Markets responded to this scenario by delivering positive returns for both equities and bonds. In February however risk-off overtook the risk-on psychology and markets declined for the month. Contributing to this shift in sentiment were inflation readings that refused to materially recede and a labor market that continued to show ongoing strength. This combination led many investors to question their belief in the soft-landing scenario that had given them a higher level of confidence the prior month. Markets returned to their production of positive returns in March as the failures of Signature Bank and Silicon Valley Bank (the second and third largest failures in U.S. history) led monetary officials to take extraordinary measures in response. These measures resulted in a lowering of interest rates and the return of a risk-on mentality in the equity markets as investors looked to the aforementioned bank failures as a path to an easing of restrictive monetary policy.
Overarching these first quarter developments is the ongoing issue of the debt ceiling for the U.S. government which reached its limit of $31.4 trillion in January. At this time, the Treasury is using “extraordinary measures” such as suspending payments to long-term programs for government employees to provide some financial flexibility. While the probability of an actual default is extremely low, financial markets could be negatively impacted over the next couple of months if the issue is not resolved.
Second Quarter Outlook
As we begin the second quarter the outlook for real GDP growth for the period is currently anticipated to deliver positive, but much lower, growth. According to the consensus outlook of economists surveyed by Bloomberg, first quarter growth is projected to be 1.3% and the second quarter estimate currently registers 0.2%. There is, however, a wide level of variability around this consensus outlook. Much of the variability has to do with the ongoing threat of a recession developing and when it would potentially begin. We have acknowledged the potential for a recession in previous communications and have stated that while one could certainly occur, we did not see it developing in the near future. Given the consensus view a recession is not anticipated in the first half of this year.
In regard to the discussion of recession, there continues to be conflicting data points about the strength of the economy. For example, labor markets have been remarkably consistent and resilient in terms of job openings and unemployment claims. In contrast to these measures is a growing number of layoffs throughout the U.S. Thus far the reductions in headcount have been concentrated in technology companies but this may be starting to widen somewhat as it is being widely reported that McDonald’s is in the process of notifying hundreds of employees that they are losing their jobs.
Another positive on the economic front is housing. Over the last months we’ve seen improvement with an increase in the latest reading of the National Association of Homebuilders Index and higher-than-forecast results for new and existing home sales.
Adding to the muddled collection of data points are the ISM and Markit purchasing manager surveys. Their recent results indicate a contracting manufacturing sector that suggests economic weakness while the services sector continues to point to ongoing growth.
Going forward, we will continue to evaluate these and other economic indicators, individually and collectively, to discern the direction of the economy and the velocity at which it is expected to move. These assessments will then be incorporated into our investment process and applied within our various strategies.
Asset Allocation Overview
With bonds and stocks both generating positive returns for the quarter, the performance of our strategic allocation investment objectives was positive as well. This represented the second consecutive quarter of positive returns helping to distance investors from the negative results experienced prior to 2022’s final quarter.
Over the course of the first quarter, we maintained a neutral positioning posture relative to our strategic benchmarks. Our philosophical tenet of emphasizing a longer-term view of markets led us to maintain our neutral positioning. This served our clients well as underneath the surface of positive results for financial assets, there were numerous twists and turns that took place during the quarter that would have required numerous shifts to capture the benefits of these gyrations. For example, within the domestic equity markets we saw small cap stocks, as represented by the Russell 2000 Index, outperform their large cap counterparts, as measured by the Russell 1000 Index, in each of the first two months of the quarter but trail over the three-month period after an extremely weak showing in March. Also, after being outperformed by over 20 percentage points in 2022, growth stocks outperformed value stocks by over 13 percentage points for the quarter.
The bond market also saw its share of volatility for the period. The 10-year U.S. Treasury issue for example, saw its yield change by 35 or more basis points over each month of the quarter. Even more impressive is the fact that the two-year Treasury saw its yield decline by more than a full percentage point in three trading days as markets reacted to the monetary policy shift enacted by the Federal Reserve in response to the failure of Silicon Valley Bank.
As we work to discern the go-forward economic and financial market landscapes, we will continue to focus on the long- term view that has led to our neutral positioning. And finally, we encourage investors to review their objectives to ensure they are properly aligned with their investment goals.
The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.
This content is provided for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and should not be interpreted as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.