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Equity markets started 2023 with a bang. The technology stocks that suffered over the past year, as bond yields increased and pressured multiples, were able to lead the charge higher as investors began to anticipate the peak in central bank tightening. For most assets, the returns we have seen over the first quarter have been a mirror image of what occurred last year.
Value and cyclical stocks, which proved to be a safe haven last year, have lagged behind their growth counterparts. And now everyone is having the same debate: Was this simply a rebound from oversold levels for technology or is this the start of a new bull market?
It’s probably too soon to signal the all-clear. The measure of calm the markets experienced to end March seems premature. Signals of a pause from rate hikes are happening as much because of stress in the regional banking system as the result of a victory over inflation. That isn’t necessarily a good thing.
The effects of the second- and third-largest bank collapse in American history have yet to be fully understood. Yes – bank management teams were at fault for how they positioned their balance sheets, but this is also a direct result of the dramatic pace of rate tightening that occurred last year.
Still, it’s unlikely that banking is the only sector that is under stress from these rate hikes. We will soon know more as we head into another highly anticipated earnings season. Markets rallied during the past few earnings releases as companies were able to meet expectations thanks to their cost-cutting efforts. The question remains: Can this happen again, or will we see more signs of stress that will lead us into a recession?
As a contrarian, the fact that it seems everyone is calling for a recession and expecting a pullback could be taken as a bullish signal. After all, markets tend to do what makes most people wrong. Many may be looking over the earnings recession valley in areas such as technology, but that seems too easy. Complacency can be dangerous.
Central bankers are getting closer to wrapping up their aggressive pattern of rate hikes, but they still need to see more evidence that inflation is receding before we know for sure they are finished. As economic measures begin to cool, a worst-case scenario of stagflation remains a risk, which will keep a bid to real assets such as gold.
After a year where not much went well, it’s refreshing to see a positive start to markets in 2023. But risk remains. Following the stress in the banking system, this earnings season should provide clarity surrounding the impacts of the Fed tightening. And while rate hikes may be nearing an end, their effects are still working through the system, and their impact is not fully known. Together, these factors will help determine if the optimism of March was warranted or premature.
Greg Taylor, CFA, is the Chief Investment Officer of Purpose Investments Inc.
Notes and disclaimer
Content copyright © 2023 by Purpose Investments Inc. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. This article first appeared on the “Macro commentaries” page of the Purpose Investments’ website. Used with permission.
Charts are sourced from Bloomberg unless otherwise noted.
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