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Markets made up some ground in the first quarter of 2023, after a tough year in 2022. The S&P 500 was higher for the first quarter (up 7.0%),but was outpaced on the upside by the tech-heavy Nasdaq (up 16.8%). In fixed income, returns were also broadly positive as Treasury rates rallied across the curve. These positive market returns were a welcome turn-around from the negative performance in both asset classes in 2022. Looking at other indicators, for Q1’23, the US dollar index (DXY) was slightly lower (down -1% YTD), while the benchmark 10-year US Treasury rate (UST10) declined to 3.48% (down 40 bps YTD). The price per barrel of WTI oil declined by -5.6% YTD, closing out March at $75.68.
Some of our predictions from our last quarterly review took place as predicted, while other developments were unexpected. Firstly, our prediction that the Fed’s cycle of interest rate hikes should be nearing an end looks likely to happen as expected. Annual headline inflation (CPI YoY) printed its ninth straight monthly declines, to 5.0% in March. This has allowed the Fed to slow its pace of hikes, with the Fed raising rates by only +25 bps at its first two FOMC meetings of 2023. Markets are currently pricing only one more hike of +25 bps for May, followed by rate cuts later in the year. As noted last quarter, “we think financial markets will welcome the shift from the most hawkish Fed in a generation to a more balanced Fed, giving the economy more time to absorb past hikes.”
Part of the reason for the Fed to slowdown was due to some unexpected developments. In March, there was a notable U.S. regional bank failure, Silicon Valley Bank, caused by stress over securities losses and a subsequent deposit run on the bank. Shortly thereafter, Credit Suisse faced a loss of market confidence and was acquired by UBS. While we will not delve into the intricacies of bank accounting standards and deposit betas in this newsletter, the takeaway from the recent banking sector stress is that global markets are now clearly manifesting impacts from the Fed’s fastest hiking cycle in decades. The latest GDPNow forecast for Q1’23 real GDP is 2.5%, down from 3.5% in March.
Across the pond, European equities outperformed the U.S. large caps for the year-to-date. This can be attributed to a milder-than-expected winter and a rapid response to source energy from alternative sources, easing fears of energy constraints. As well, the reopening in China should be positive for Europe, given trade linkages. Finally, we note that European equities (using the Euro STOXX 50) still trade at a substantial valuation discount to U.S. equities (vs. S&P 500), giving the continent an advantage versus the U.S. on valuation. Elsewhere, emerging markets were also up for Q1’23, but lagged developed markets. This is likely due to an easing in the commodity cycle, as well as fears of global economic slowdown and a preference for safe haven markets.
Looking ahead for the rest of 2023, we believe that interest rate policy will take a backseat to broader economic conditions. On that front, unfortunately, the case for a recession in the U.S. is building. Some data points: earnings for 1Q’23 declined, indicating weaker corporate earnings; recent bank sector stress is likely to cause a pull-back in bank lending and credit creation give the uncertainty around deposit trends; recent JOLTS (job vacancies) data have shown softer hiring trends; ISM manufacturing fell to its lowest level in 3 years; and Wall Street economists’ forecasts now target 65% odds of a recession within the next 12 months. That said, the most recent employment report, along with ongoing disinflation, makes the case that a soft landing for the U.S. economy remains possible.
Perhaps just as importantly as the macro environment, we expect 2023 to restore more normalcy to market correlations. One of the most challenging aspects of markets in 2022 was the positive correlation between bonds and equity, driving balanced portfolios to offer little solace. Now that we have a return to positive real rates across most of the Treasury curve (based on market forward inflation expectations), we expect that the benefits of diversity across asset classes may start to normalize.
As we believe the chances of recession remain elevated, we are maintaining our cautious stance on portfolios, with a preference for “up in quality” fixed income investments and even cash. We have not seen today’s levels on short-term rates since before the financial crisis. Although we do see short-term rates as attractive, we encourage investors to continue thinking long-term and consider adding duration in their flexible allocations. With the yield on investment grade corporate bonds over 5%, investors looking for income could consider buying longer term bonds in order to garner attractive yields over a longer time horizon, rather than simply park cash in short-term Treasury bills. We will be looking for opportunities to shift our dynamic allocation tilt back to neutral, but for now maintain our cautious stance given the increasing chance of recession.
Notes: Asset class performance is in USD and refers to the following indices: Equities: US Large Caps (S&P 500), Emerging Markets (MSCI EM), Europe (MSCI Europe), Japan (MSCI Japan). Fixed Income: 10-Yr. US Treasuries (BofAML US Treasury Current 10-Yr.), Emerging Markets Sovereign (USD) (JPM EMBI Global), Emerging Markets Sovereign (LCL) (JPM GBI EM Global Diversified), US High Yield (BofAML US HY Master II), US Investment Grade (BarCap US Aggregate Bond), and Developed Markets Sovereign (excl. US) (JPM GBI Global Ex US). Source: Morningstar. (1) Strategy returns net of mutual fund expenses and Amerant Investments standard management fees.
On this table, you can see the returns for the first quarter of this year as well those for the full year 2022.
Q1’23 saw positive returns across all asset classes. Most notably, equities rallied across all geographies led by Europe and the U.S. Fixed income returns were also positive after a brutal 2022 with 10Y U.S. Treasuries up 3.7% for Q1 2023. U.S. High Yield returned 3.7% while Emerging Markets hard currency bonds returned 2.3%.
As mentioned in the “Markets Overview” section above, we believe that the Fed’s rate hiking cycle is nearly over, with only one more rake hike priced in for May 2023. While we are somewhat cautious on High Yield, given the likelihood of a slowing economy, we believe Investment Grade bonds should do well in the current environment. We currently maintain a bias for higher quality corporate bonds for most clients looking for income. For equities, we believe that equities broadly are roughly fair value but not yet pricing in recessionary valuation multiples and earnings declines. We would advocate a targeted approach to equities, with a focus on specific stocks and sectors with conservative multiples.
(1) Strategy returns based on the total return of the underlying mutual funds, including reinvestment of dividends and change in NAV. Net of mutual fund expenses and Amerant Investments standard management fees. Returns may vary. Past returns are no indication of future performance.
(2) Monthly returns before February 2010 are those of the offshore corresponding strategies. For the Dynamic portfolio, monthly returns before November 2009 are those of the Income & Growth portfolio, which is the neutral positioning of the Dynamic portfolio. Dynamic portfolio started in November 2009.
During Q1’23, all of the managed Portfolios had positive returns. The Income Portfolio returned 3.6% in Q1’23, the Income & Growth Portfolio returned 4.6%, the Growth Portfolio returned 6.6%, and the Dynamic Portfolio, positioned in Income, returned 3.5% during the quarter.
For the full year 2022, the Income Portfolio returned -14.9%, the Income & Growth Portfolio returned -17.3%, the Growth Portfolio returned -20.1%, and the Dynamic Portfolio, returned -17.1%. As mentioned previously, there were few places to hide last year markets faced significant headwinds: High and persistent inflation (exacerbated by the Russian invasion of Ukraine), tightening monetary policy, rising interest rates, and slowing economic growth.
In 2022, we positioned portfolios more defensively to be better prepared to withstand an environment of increased volatility due to continued fears of recession and geopolitical risk. Looking ahead, we are maintaining our cautious positioning given the heightened economic uncertainty and recession risk. That said, we are preparing to add risk if we valuations become attractive and breach our downside targets.
As always, we take the trust you have placed in us very seriously. In our day-to-day operations, we continue to follow current events and the reactions of the markets closely, and we stand ready to adjust your portfolios accordingly.
To obtain more detailed information on our market views or the performance of your advisory portfolio, please contact your investment consultant at Amerant Investments by calling (305) 460-8599.
Amerant Investments, Inc.
The model portfolios offered by Amerant Investments and described herein invest solely in mutual funds. Before investing, you must consider carefully the investment objectives, risks, charges, and expenses of the underlying funds of your selected portfolio. Please contact Amerant Investments to request the prospectus of the funds containing this and other important information. Please read the prospectus carefully before investing. Past performance is no guarantee of future returns. The value of the investments varies, and therefore, the amount received at the time of sale might be higher or lower than what was originally invested. Actual returns might be better or worse than the ones shown in this informative material.
This release is for informational purposes only. Past performance is no guarantee of future results. While the information contained above is believed to be from reliable sources, no claim as to their accuracy is made. Amerant Investments, Inc. provides no advice nor recommendation, or endorsement with respect to any company or securities. Nothing herein shall be deemed to constitute an offer to sell or a solicitation of an offer to buy securities. Member FINRA/SIPC, Registered Investment Adviser. Amerant Investments does not provide legal or tax advice. Consult with your lawyer or tax adviser regarding your particular situation.
Not FDIC Insured | Not Bank Guaranteed | May Lose Value | Not Insured By Governmental Agencies | Member FINRA/SIPC, Registered Investment Advisor
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