March 2023 Market Update
Banking Sector
The Fed has raised rates at an unusually aggressive pace over the last 12 months. This directly impacts banks’ earnings from net interest margin, the spread between deposit rates and interest rates for lending. Last Tuesday, Powell mentioned they intended to keep rates higher for longer, changing the banks’ calculation for future net interest margin.
In response, Silicon Bank decided to sell $20 billion worth of low yielding investments to reinvest at a higher rate. However, this cost them $2 billion in losses. At market open, analysts saw the balance of the portfolio had losses. $42 billion was withdrawn the next day as depositors became nervous, producing a negative equity value for the bank. Regulators took over the bank, and peer banks entered the radar for similar potential issues. Similarly, Signature Bank failed due to crypto exposure and balance sheet mismanagement.
Both banks were not traditional banks, having strictly large commercial deposits and mostly uninsured deposits. The lack of diversification in business lines also weighed negatively on the banks.
Federal Reserve announced all depositors would be made whole without cost to the tax payer. Banking has always relied on capital and confidence, and the Fed is trying to provide both of these to support the banking sector. In addition, the Fed covered the deposits of Silicon Valley and Signature to stem outflows from other small to mid-size banks. Without this strategy, the big banks would likely just grow more powerful, and there would be less diversity in the banking system.
While most analysts believe this is a fairly isolated event, the ripples will still be felt throughout the banking sector and will lead to heightened volatility in the near term.
Russia/Ukraine
We have passed the one-year anniversary for this conflict. However, Russia has struggled in many areas: the military, diplomatically, economically, and strategically.
They have lost 150,000 troops and numerous apparatus.
Sweden and Finland have requested to join NATO. In addition, the Russia/Ukraine conflict has reaffirmed existing NATO allies. Many of these countries have seen a large increase in defense spending as well.
Russia’s economy is struggling, and many skilled workers are leaving the country.
Strategically, Russia attempted to weaponize commodities, such as oil and natural gas. However, oil is now 16% lower than at the start of the conflict, trading at $32 discount. Natural gas has also fallen 69% as Europe has dramatically decreased its reliance on Russian natural gas by 87%.
At the height of the conflict, Russia controlled 27% of Ukraine’s territory. However, Russia has lost half of that territory.
The most likely outcome of the conflict is a stalemate via a prolonged conflict.
China Relations
Politically and socially, the U.S. has a historically unfavorable opinion of China. This is seen in a recent poll where 80% of consumers found China unfavorable. The House also voted 417-0 to condemn China’s recent actions with the spy balloon.
Economically, China is the second largest foreign holder of Treasuries behind Japan, and they are the largest importer of goods into the United States.
Militarily, China has the world’s largest populations but not a large position in machines of war. However, many experts believe the next phase in warfare will be via technology rather than physically.
The key to stability between the U.S. and China is the personal relationship between the Biden administration and Xi as Biden and Xi have an amicable working relationship.
The Economy & Markets
Earlier in the year, we expected to see continued increased volatility for the first half of the year, and that has proven true. For the stock market so far this year, most indexes are still positive for after a good start in January. However, the bond market has seen the majority of the volatility.
A question that is a priority for most people is the likelihood of a recession and what may happen to avoid one this year. The Fed’s primary objectives are maximum employment and inflation staying low (2% is the ideal rate). While employment is currently strong, inflation is still too high, driving the Fed’s policy of aggressive rate hikes. Raymond James thinks that the Fed will still raise rates next Wednesday at the FOMC meeting. However, the banking situation over the past week or so has changed the calculations and the projections of many economists. The – year Treasury yields have dropped more than 100 basis points or 1%. This is the biggest weekly move since October of 1987. Because of this volatility and banking concerns, many economists are saying that the Fed will actually cut rates later in the year, and the market is currently confirming that that with the probability figures.
The US is not alone in having higher interest rates as this trend is happening around the world. Other developed countries are up almost 3% or more over the past 15 months. This has been a positive for savers, not necessarily investors, and a negative for borrowers. However, this is the goal to slow down inflation around the world.
Raymond James’ CFO is currently forecasting for the US to enter a recession in either the second or third quarter of the year. While the statistics and data are not pointing to a recession yet, it is likely one occurs later in the year as the Fed continues to raise interest rates. When there is a recession, most analysts believe it will be mild one and one where we may not re-test the lows in the stock market from the second half of last year.
As a reminder, the stock market is not the economy, and the economy is not the stock market. One can be doing well, while the other is doing poorly and vice versa.
Fixed Income
We continue to find short term investment grade corporate bonds attractive. You are able to receive the same yield as other types of bonds while taking much less risk and having a shorter duration.
Municipal bonds are also attractive in the right scenario as the tax equivalent yield is strong right now.
When rates do come down, we could be entering an attractive time to own bonds again if the projections are accurate.
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Will Caywood, Katie Edmonds or Jeff Fehrman and not necessarily those of Raymond James.
This material is being provided for information purposes only and is not a complete description, nor is it a recommendation.
Expressions of opinion are as of this date and are subject to change without notice.
Investing involves risk and investors may incur a profit or a loss.
