as of March 31, 2023
Global markets moved higher during the quarter as investors appeared to remain hopeful for a soft landing. However, volatility was elevated at times as stresses in the banking sector and uncertainty over monetary policy weighed on markets. Global economic growth has been more resilient than most economists expected. In the US, GDP grew at an annual rate of 2.6% during the fourth quarter, and economic data tended to surprise to the upside during the first quarter. This led the market to price the Federal Reserve to stay higher for longer into early March.
However, in March signs of a potential banking crisis began to unfold. Silicon Valley Bank became the first in a string of banks to come under stress. Regulator intervention looks to have contained the crisis for the time being. The causes appear to be poor management at the affected organizations. It appears unlikely to develop into a broader, systemic issue. One potential result could be tighter lending standards, increasing the risk of a recession. It could also reduce the need for the Fed to tighten policy further. While the bond market has priced the potential for one more rate hike, it has priced an easing cycle to begin in the second half of 2023.
Global equities posted gains during Q1, with the MSCI ACWI index rising 7.3%. The index has declined 7.4% over the past one-year. The S&P 500 gained 7.5% during the quarter, but it remains down 7.7% over the past year. International developed stocks gained 8.5% in Q1, and are down 1.4% over the past year. A weaker dollar added 1% to US dollar returns during the quarter. Emerging market equities rose 4.0% in Q1 and have declined 10.7% over the past year.
Within fixed income (bonds), the Bloomberg Aggregate gained 3.0% during the quarter. Treasuries gained 3.0%, lagging corporate bonds, which gained 3.5%. With the exception of the short-end of the curve, the yield curve generally shifted lower during the quarter.
Global developed REITs gained roughly 1% during Q1, lagging broader equity markets. Infrastructure stocks gained 0.6% during the quarter. Commodities generally declined during the quarter. Gold was an exception, rising almost 9% on safe haven demand during the banking scare and falling real rates. Natural resource stocks declined almost 3% during Q1.
Encouragingly, inflationary pressures have maintained their downward momentum. The gradual easing of supply chain issues and weaker demand resulting from tight policy should slow core inflation. One ongoing area of concern for the inflation picture is the continued strength of the labor market, although increases in average hourly earnings appear to be moderating.
A mild recession in the US later in 2023 still appears likely. As long as inflation continues to fall towards the target, we do not expect a mild recession to be especially bearish for equities because it will allow the Fed to ease policy. Easier monetary policy could offset the negative impact of weak earnings for equities. The biggest downside risk we see is if inflation remains sticky amid a slowing economy. This could require a far more forceful Fed response than what is currently priced by markets and a deeper recession. This could result in further weakness in stocks and bonds.
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