Authored by :
Michael G. Dow, CAIA, CFA, CPA, Chief Investment Officer
Julien R. Frazzo, Director of Risk Management and Securities Research
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The Quick Facts
- A quarter characterized by turbulent swings in inflation and rate hike expectations
- For the second consecutive quarter, the S&P 500 gains 7.5% while the Nasdaq enters a new bull market
- Growth significantly outperforms Value in 1Q 2023
- Rates volatility soars to near 15-year highs on the fallout from banking turmoil
- Federal Reserve (Fed) balancing inflation vs. financial stability
- Core Personal Consumption Expenditures (PCE) Price Index rises less than anticipated in February
The first quarter of 2023 was characterized by turbulent swings in inflation and rate hike expectations. Stock and bond markets rallied in January amid optimism that global central banks, led by the Fed, might soon halt interest rate hikes, perhaps even setting the stage for rate cuts by the end of the year. But stronger-than-anticipated February economic data dashed those hopes.
March was a volatile month for the capital markets as the Fed’s 13-month rate hike cycle contributed to stresses in the banking system, resulting in the closing of Silicon Valley Bank and Signature Bank, a forced takeover of Credit Suisse, government deposit backstops, and a new special lending facility for banks. That triggered fears of global banking contagion that caused investors to flee stocks for safer assets, including bonds. By the end of the month, those fears eased, with investors again raising their expectations the Fed would cut rates by the end of the year, especially after the Fed hinted it may at least pause its interest rate campaign.
Despite the surrounding chaos, the market managed to rebound in March. Boosted by Tech, the S&P 500 posted a gain of 3.7% in March and 7.5% YTD. Technology and Communication Services were the best-performing sectors for the quarter, up 21.6% and 21.1%, respectively. The Financials sector was, unsurprisingly, the laggard, down 9.6% in March and 5.5% for the quarter.
March Asset Class Performance
After being badly beaten down in February, the Nasdaq-100 Index took flight in recent weeks. The flight to mega-cap cash-rich technology stocks amid the latest bank turbulence buoyed the index. The tech-heavy index surged to a new bull market, up more than 20% from its December 28 low.
Seven of the eleven S&P 500 sectors were higher in March, led by Technology (+10.9%) and Communications (8.6%). Technology gained 21.6% in 1Q, led by the semiconductor industry, while on the other end, Financials declined 9.6%, followed by Real Estate (-1.5%) and Materials (-1.0%).
On a total return basis, large cap growth stocks were the top performers for the month and quarter, with the Russell 1000 Growth index up 6.8% in March and 14.4% YTD. Large cap value stocks were barely up as the Russell 1000 Value index was down 0.5% in March but rose just 1.0% YTD. Despite the short-term reversal, the outperformance of Value over Growth remains a major longer-term investment theme in an environment where long-dated cashflows of growth companies are discounted at higher rates. The ESG segment of the market, as measured by the MSCI USA ESG Select Index, was up 3.1% in March, 0.6% less than the S&P 500. Over the last three years, the ESG index is up 64.7% and approximately 0.6% ahead of the S&P 500 on a total return basis.
U.S. bond markets suffered their worst returns in history in 2022. They recovered slightly in the first quarter as yields, which move inversely from bond prices, dropped. The 10-year U.S. Treasury yield opened the year at 3.87% and ended the quarter at 3.47%. In between, it fell as low as 3.30% and rose as high as 4.05%. For the quarter, the Bloomberg U.S. Aggregate Bond Index gained 3.0%.
Stresses in the U.S. banking system have led to a conundrum for the Fed, which is aiming to balance tensions between price stability and financial stability. At its March meeting, the Fed pushed forward with another 25bp rate hike. Fed Chair Jerome Powell emphasized that the U.S. banking system was sound but also made it clear that the FOMC (Federal Open Market Committee, the Fed’s rate-setting body) was incorporating the real economic impact from the banking stress via the lending channel. The probability for another 25bps rate hike at the May meeting is currently 55%, but more importantly, the conversation is shifting to when and how aggressively the Fed will begin cutting rates. Treasury yields drifted lower at the end of a quarter of wild swings. Market participants have struggled to adjust to banking stress and the shifting outlook for interest rates, amid high inflation and threats to economic growth.
As investors sought less risky assets late in the quarter, prices for gold (viewed as the ultimate safe haven asset) surged. For the quarter, spot gold increased 8.0% to $1,969 per troy ounce, its highest level since March 2022 and near an all-time high. Oil prices fluctuated during the quarter, falling sharply as concerns about the banking system arose but rebounded along with stock prices just prior to the quarter’s end. West Texas Intermediate (WTI) contracts fell 5.7% to $76 per barrel in the three-month period. Bitcoin soared 71.7% during the quarter to $33,274, and Ethereum increased 51.6% to $1,365. The U.S. Dollar Index (DXY) was down 2.3% in March for its fifth decline in six months.
While volatility was extreme within select equity sectors, mainly financials, the CBOE Volatility Index or VIX, also known as the fear gauge, was relatively tame. Its highest close in March was 27 while having only four daily closes above 25 before closing the month below 19. Volatility was most profound within the rates complex, particularly in the belly of the curve. The 2 to 5-year U.S. Treasury yields had their biggest weekly decline since the 9/11 terrorist attacks in 2001, while the MOVE Index (measuring interest rate volatility) reached its highest level since the peak of the Great Financial Crisis in 4Q 2008. The entire 2-year / 30-year U.S. Treasury yield curve is trading below Fed Funds, and it has been one year since the 2s-10s U.S. Treasury spread first inverted. The trough in the 2s-10s spread (-108 basis points) was reached on March 8, which coincided with Chair Powell’s semi-annual Congressional testimony, during which he walked back his emphasis on “disinflation” at the prior press conference and delivered a second straight +25bps rate hike.
Chart of the Month – The MOVE Index
The MOVE index is a measure of the volatility of the U.S. Treasury bond market. The acronym “MOVE” stands for “Merrill Lynch Option Volatility Estimate.” The index was created by Merrill Lynch in 1988 and measures the implied volatility of 1-month Treasury bond options, which are contracts that give investors the right, but not the obligation, to buy or sell Treasury bonds at a certain price and date in the future. The MOVE index is calculated based on the prices of these options and represents the market’s expectation of the future volatility of Treasury bonds over the next 30 days.
Investors and traders use the MOVE index to gauge the level of risk and uncertainty in the Treasury bond market. A higher MOVE index indicates higher expected volatility, while a lower MOVE index indicates lower expected volatility. The index can also be used to hedge against changes in interest rates or to speculate on market movements.
The MOVE Index has a long history of providing strong signals about bond market sentiment. The financial markets have seen an uptick in volatility in the wake of the recent bank failures, but the VIX is still trading well below “crisis” levels. The highest close in March 2023 for the CBOE Volatility Index was 27, which is only eight points higher than its long-term average of 19. That is well below the record highs observed during the 2008-2009 Great Financial Crisis (GFC) when a slew of bank failures pushed the VIX above 80. However, volatility has spiked to record levels in other niches of the financial markets. The MOVE Index hit a 15-year high. The sharp increase in the MOVE index reflects the extraordinary volatility seen in the U.S. Treasuries market over the last weeks.
Quote of the Month
“The true investor welcomes volatility.” — Warren Buffett
Major Asset Class Dashboard
Important Disclosure: This report is for informational purposes only. Opinions expressed herein are subject to change without notice. Beacon Pointe has exercised all reasonable professional care in preparing this information. The information has been obtained from sources we believe to be reliable; however, Beacon Pointe has not independently verified, or attested to, the accuracy or authenticity of the information. Nothing contained herein should be construed or relied upon as investment, legal or tax advice. All investments involve risks, including the loss of principal. Investors should consult with their financial professional before making any investment decisions. Past performance is not a guarantee of future results.
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