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U.S. equities posted positive returns across the market cap spectrum in Q1 2023, with the S&P Composite 1500^® up 7.2%.  The rise, however, was bumpy as investors navigated the banking-related crunch and its aftermath, with the biggest U.S. bank default since 2008, which also briefly spread to Europe.  A pattern of reversals from last year was well underway during the first two months of the quarter, when Communication Services and Consumer Discretionary were the top performers within the S&P 500^®, while the Energy and Health Care sectors were the laggards.  After the U.S. banking hiccup in March, the Financials sector (-5.6%) became the biggest quarterly underperformer, while Information Technology (up 22%) and Communication Services (up 20.5%) took the top spots.  Recent returns of the Financials sector have diverged materially from their pattern of moving closely with the 10-year Treasury yields.  Weakness in U.S. regional banks also flowed through into the underperformance of the U.S. small-cap space, reflected in the sharp fall in the S&P SmallCap 600 versus S&P 500 Information Technology performance in March.  Secular growth outperformance and defensive sectors’ underperformance was in line with the performance of S&P 500 factors—high beta and growth took the top spots, while high dividend, pure value and low volatility were near the bottom of the table.  Of the 25 Kensho subsectors, 22 were higher this quarter, the first time since the highs posted in Q1 2021.  Most non-U.S. equity markets were also up this quarter—eurozone equities (up 10.5%) markedly outperformed U.S. equities, while emerging market equities posted relatively modest gains (up 2.3%).

The U.S. Fed’s tightening path was well anticipated by the markets at the beginning of the year, with expectations for the terminal overnight rate at one point hitting nearly 5.7%.  Continued pressure from sustained inflation and overall labor market strength were weighing on the Fed, until the crisis from Silicon Valley Bank (SVB) erupted.  As the contagion spread, the rates market immediately repriced the Fed rate hike path lower for the year.  U.S. Treasuries attracted significant inflows this quarter and posted one the best quarterly returns (3%) in nearly three years.  However, tighter financial conditions in the aftermath of the SVB collapse have seen high yield, and other higher risk segments of the debt markets show weakness.  The U.K. and European Central Banks stayed on course with the U.S. in terms of rate hikes during Q1.  The U.S. dollar, nonetheless, weakened across most of its heavily traded crosses this quarter, as expectations around a pause in the Fed’s rate hikes increased.  Gold also benefited from the rate repricing and bank credit concerns, surging above USD 2,000 to near-historic levels.  Oil prices stabilized this quarter after a downtrend over the previous two quarters, but it started to move higher after OPEC announced surprise oil cuts at the start of April.  Elevated U.S. sovereign CDS spreads continue to reflect the market unease around a potential deal before hitting the U.S. government debt ceiling X date sometime in the second half of the year.

Top Three from across the New Economies

Distributed Ledger (66.7%): KLEDGER posted its best quarterly performance since its inception in late 2018, climbing back up to September2022 levels.  Unsurprisingly, this quarter’s gains closely tracked the rise in the price of Bitcoin (up 71%).  The U.S. regional banking crisis around mid-March prompted renewed interest in currency alternatives like crypto and gold assets.  Almost all of the index constituents posted positive quarterly returns with the exceptions of Turkish firm Turkcell (-10%) and Financials firm ING Groep (-2%).  5 of the 12 constituents, primarily involved with the crypto mining space, posted triple-digit quarterly returns, with the top spots taken by Riot Platforms (up 195%) and Marathon Digital (up 156%).  The index continues to be dominated by the Application Software sub-industry (up 55%), followed by Financials sector firms (up 30%).  It also remains the most volatile across the Kensho subsectors due to a high beta to the crypto markets from its exposure to crypto mining companies.

Virtual Reality (27.2%): KVR’s best quarterly performance in two years was supported by positive contributions from nearly all of its constituents (17 out of 19).  The Semiconductors industry played an integral part in KVR’s recovery this quarter as the index neared its one-year peak.  NVIDIA was the top performer within the index (up 90%), doubling its price over the six-month period and becoming the best YTD performer among the S&P 500 constituents.  Investor sentiment toward NVIDIA likely took a hit from the downturn in crypto assets in 2022, but there has been widespread optimism around the company’s recent push toward creating products geared toward AI applications.  Meta, the second-best YTD performer (up 76%) within the S&P 500, was another top contributor to KVR’s performance.  Meta has also been on a comeback track, returning closer to its one-year peak on the back of strong Q4 2022 earnings reports and a focus on further incorporating AI-powered tools within their apps.  Faro was the notable underperformer (-16%) within KVR, as it slid close to its lowest level in over five years.  This imaging devices and computer-aided measurement firm posted lackluster Q2 2022 results and has been on a downward trend since reaching its peak in early 2021.  

March 2023 Commentary

The banking sector dominated headlines over the past few weeks after the dramatic collapse of Credit Suisse and two regional U.S. banks: Silicon Valley Bank and Signature Bank.  Fear of the issues becoming more widespread caused some volatility in the markets, but market analysts suggested the events were idiosyncratic rather than systemic.

Some investors in Singapore would also have felt the heat in the write-down of Credit Suisse Contingent Convertible (CoCo) bonds, which included an SGD 750 million bond issued in June 2019 with a 5.63% coupon.  On a positive note, the Monetary Authority of Singapore (MAS) reaffirmed the financial hierarchy of payout for distressed banks, such that equity shareholders would continue to absorb losses ahead of additional tier 1 and tier 2 bond holders.

Against the backdrop of bank stress, the U.S. Federal Reserve raised interest rates by a conservative 25 bps in the latest move to quash inflation with “more dovish tones” according to some observers.

At the end of an extraordinary month, the S&P 500^® inched up by 3.51%.  U.S. Treasuries—represented by the iBoxx $ Treasuries—were also in the black, up 3.1%.  Despite woes in some major banks, confidence in the sector remained seemingly strong among investors as both the iBoxx $ Financials (up 1.47%) and iBoxx $ Banks (up 1.52%) managed to post positive returns in March.

As shown in Exhibit 1, the iBoxx USD Asia ex-Japan recovered most of its February losses, gaining 1.18% in March.  The gains were driven by strong performance in investment grade bonds.  The index yield contracted 23 bps to 5.93%, while spreads widened by a similar amount to 219 bps.

Investment grade bonds had a positive March, advancing 1.77% with gains across all rating and maturity ranges.  In contrast, the high yield segment posted losses across most maturity and rating segments.  CCC rated bonds in particular lost more than 8%, with double-digit losses in the 3+ maturity range.

Monthly performance, maturity, yield and duration of the iBoxx ALBI, iBoxx ABF and iBoxx SGD Indices.

The banking sector dominated headlines over the past few weeks after the dramatic collapse of Credit Suisse and two regional U.S. banks: Silicon Valley Bank and Signature Bank.  Fear of the issues becoming more widespread caused some volatility in the markets, but market analysts suggested the events were idiosyncratic rather than systemic.

Some investors in Singapore would also have felt the heat in the write-down of Credit Suisse Contingent Convertible (CoCo) bonds, which included an SGD 750 million bond issued in June 2019 with a 5.63% coupon.  On a positive note, the Monetary Authority of Singapore (MAS) reaffirmed the financial hierarchy of payout for distressed banks, such that equity shareholders would continue to absorb losses ahead of additional tier 1 and tier 2 bond holders.

Against the backdrop of bank stress, the U.S. Federal Reserve raised interest rates by a conservative 25 bps in the latest move to quash inflation with “more dovish tones” according to some observers.

At the end of an extraordinary month, the S&P 500^® inched up by 3.51%.  U.S. Treasuries—represented by the iBoxx $ Treasuries—were also in the black, up 3.1%.  Despite woes in some major banks, confidence in the sector remained seemingly strong among investors, as both the iBoxx $ Financials (up 1.47%) and iBoxx $ Banks (up 1.52%) managed to post positive returns in March.

It was a good month for all local markets in the iBoxx Asian Local Bond Index (ALBI).  The overall index (unhedged in USD) was up 3.21% in March; capital gains and appreciation of most local currencies against the U.S. dollar contributed to the positive performance.

In local currency terms, South Korea (up 3.06%), Hong Kong (up 2.88%) and Singapore (up 2.86%) led the gains.  China off- and onshore bonds were among the poorest performers, returning 0.50% and 0.61%, respectively, but both markets still managed gains in a decent month for fixed income, despite woes in banking-related additional tier 1 (AT1) bonds.

The largest gains were concentrated at the long end of the curve, with Hong Kong 10+ (up 6.58%), Singapore 10+ (up 5.32%) and South Korea 10+ (up 4.70%) leading the pack.  Besides the top-performing segments, it was also a sea of green across maturity buckets for all eligible markets.

As of the end of March, the overall index yield declined 22 bps to 3.95%, while yields for all local markets declined.  India remained the highest-yielding bond market in the index, offering 7.45%, while Thailand (2.97%) remained the lowest-yielding market.

Key Highlights

- The S&P 500^® was up 3.51% in March, bringing its YTD return to 7.03%.
- The Dow Jones Industrial Average^® rose 1.89% for the month and was up 0.38% YTD.
- The S&P MidCap 400^® decreased 3.41% for the month, bringing its YTD return to 3.36%.
- The S&P SmallCap 600^® was down 5.38% in March and had a YTD return of 2.12%.

Market Snapshot

One must always try to find a silver lining to a storm. The S&P 500's total return for March was 3.67%, but the breakdown was more revealing. The 3.67% gain would have been 4.81% excluding Financials' 9.55% decline (it cost the index 1.13%) and it would have been 0.70% excluding Information Technology's 10.93% gain (it added 2.97% to the index, with Microsoft and Apple adding 1.72% and negating Financials' decline). For the Q1 2023 YTD period, the S&P 500's total return was 7.50%, and without Information Technology's 21.82% YTD gain (it added 5.34% to the overall index, with Apple and Microsoft adding 2.71%), it would have been 2.71%.

The banking events were severe: SVB and Signature are gone, and First Republic was down 89% for March. Credit Suisse had USD 17 billion of bonds completely wiped out, and the images of a run on the bank will likely stay with the regionals and investors for years, as Washington comes up with a new and improved cure. Banking issues, at this point in time, do not appear to be systemic, but withdrawals may lead to more failures.

The three "issues" were separate. SVB seems to be a traditional risk/maturity issue, which appeared to be a management failure and now also appears to be a regulatory one. Signature appears to be a portfolio issue. Credit Suisse has been having issues for years, with a UBS merger also discussed over the years. The current situation resulted in the arranged wedding (Deutsche Bank is still in motion).

I'm not belittling the event or the damage, but the market seems to have, and it has moved back to its issues—consumer spending, inflation, the Fed and profits. This is not the 2008-2009 banking situation and the market impact going forward at this point is expected to be tighter loan requirements, new regulations for regionals, lower margins for all deposit-related issues and an increased chance of a recession.

On a higher level, as U.S. Fed Chair Jerome Powell admitted, the current bank stress will tighten credit, with the result being "the equivalent of a rate hike or perhaps more than that." o, while the run was and is bad, it has slowed the economy directly and through additional concern. Absent more banking issues (runs), it appears to have reduced the need for prolonged Fed increases—so here we are talking about when the Fed will start its cuts.

Trading was noticeably active for March (the highest daily average in two years), as it differentiated business lines. The S&P 500 posted a 3.51% gain (up 7.03% YTD; Q4 2022 was up 7.08%). Of the 11 sectors, 7 were up (Information Technology was the best, up 10.87%, while Financials was the worst, down 9.74%). Breadth was positive, as 263 issues were up (32 up at least 10%) and 240 were down (53 down at least 10%). However, in Financials, 14 of the 65 were up and 51 were down, with two regional issues going into receivership (SVB Financials and Signature Bank), as one regional declined 89% for the month (First Republic Bank).

Perhaps just as significant as the sudden post-March 8 change in the banking environment was the market's view of the Fed (it increased rates 0.25% this month), with the market now split on whether there will be one more 0.25% hike at the May meeting or if we saw the end of rate hikes this month. The focus is now on when the Fed will start its interest cuts; predictions start in June, compared with the Fed dot matrix that started in 2024. Before we get there, however, the market will need to go through Q1 2023 earnings reports (17 off-fiscal issues have already reported, with 15 beating on earnings and 13 on sales), which opens with the big banks (April 14: Citibank, JPMorgan Chase, Wells Fargo) and regional ones (April 13: First Republic Bank). Analysts will be looking for reserves (bad debt allowance) and any market-to-market notes for the held-to-maturity securities, as well as commentary on expected new loan policy changes and levels. At this point, the Q1 2023 operating estimates have declined (-5.8%) and are predicting a slight (0.3%) decline over Q4 2022, with the traditional question being whether estimates have declined enough so that the results can be declared a beat and a victory, to which the historical answer has been yes.

Key Highlights

- The S&P 500^® was down 2.61% in February, bringing its YTD return to 3.40%.
- The Dow Jones Industrial Average^® fell 4.19% for the month and was down 1.48% YTD.
- The S&P MidCap 400^® decreased 1.95% for the month, bringing its YTD return to 7.01%.
- The S&P SmallCap 600^® was down 1.35% in February and had a YTD return of 7.92%.

Market Snapshot

February was no cupid; rather, it was more of a blind date, with the market not knowing what it was getting into.  Specifically, the market re-evaluated the decreasing speed of inflation, and therefore the need for the FOMC to continue to increase interest rates (as well as the potential of a 0.50% increase) and the time period it needed to keep them higher.  For February, the S&P 500 posted a 2.61% decline, after January's broad 6.18% gain and December's broad 5.90% decline (and an uplifting 5.38% in November), which left the three-month period down 2.69%; however, the index was up 3.40%YTD.

The S&P 500 started February up 2.53% from where it left off in January, as the last of the of FOMO (fear of missing out) money propped up the market.  Reports continued to show slower inflation, but the market’s interpretation then started to focus in on the slow speed of the inflationary decline and the divergence between that rate and the Fed’s target rate, with stock prices struggling to stay positive, as the data started to imply the need for higher interest rates for a longer period.  The turnaround point appeared to have come on Feb. 21, when both Home Depot (HD) and Wal-Mart (WMT) gave cautious outlooks due to consumer spending (with Wal-Mart seeing higher sales for groceries, which have lower margins); the market then added a slower economy to potentially stubborn inflation to post the worst day of the year for the S&P 500 (-2.00%, with the year only being 29 trading days old at that point).  Concern continued to grow, as the market came to grips with a lower economic outlook, a slower decline in inflation and the realization that the FOMC will most likely be increasing rates at least three more times (March, May and June), with the March 21-22 expected increase of 0.25% (futures give it a 77% chance; it was 85% last month) potentially being 0.50% (23%, which was barely viable last month).  Prices declined, and the S&P 500 went into the red (although volume wasn’t as convincing), while interest rates increased, with the U.S. one-year Treasury Bond over 5%, giving all investments a run for their money.  The S&P 500 ended the month down 2.61%, up 3.40% YTD and down 17.23% from its Jan. 3, 2022, closing high.

In the background was Q4 2022 earnings, which, with 97.1% of market value reported, were tailing off; 480 issues have reported, with 323 (67.3%) of them beating on earnings and 311 of 476 (65.3%) beating on sales.  Q4 2022 is expected to be down 1.7% from Q3 2022 earnings and down 12.7% over Q4 2021, as sales increased 2.8% over Q3 2022 (up 8.4% over Q4 2021) and are setting a new record.  Companies were able to pass along a good part of their cost increases for the quarter, which does not appear to be extending into Q1 2023.  Operating margins for Q4 2022 were expected to be 10.80%, down from 11.28% in Q3 2022 (the average since 1993 was 8.29%, and the record is 13.54% in Q2 2021).  Talk of Q1 2023 started to pick up, although estimates have been declining (down 5.4% from year-end 2022) and are expected to be up 2.0% from Q4 2022 (the second half of 2023 has held its level), which could easily turn into a down quarter.  At this point, earnings (and cash flow) are second only to the Fed meeting (March 21-22, 2023), with significant economic data expected before that, including the employment report on March 10, when many expect a downward revision of last month’s 517,000 level.

The S&P 500 closed at 3,970.15, down 2.61% (-2.44% with dividends) from last month's close of 4,076.60, when it was up 6.18% (6.28%) from the prior month's close of 3,839.50 (-5.90%, -5.76).  The index was up 3.40% YTD (3.69%), the three-month period posted a decline of 2.69% (-2.28%) and the one-year return was -9.23% (-7.69%).  The Dow^® ended the month at 32,656.70, down 4.19% (-3.94% with dividends) from last month's close of 34,086.04, when it was up 2.83% (2.93%) from the prior month's close of 33,203.93 (-4.17%, -4.09%).  The Dow was down 8.08% from its Jan. 4, 2022, closing high (of 36,799.65).  The YTD return was -1.48% (-1.13%), the three-month return was -5.59% (-5.18%), the one-year return was -3.65% (-1.59%) and the 2022 return was -8.78% (-6.86%).