With the 1^st quarter of 2023 behind us, let’s take a look at the performance of the broad indices and look ahead to the next 3 quarters.

Year-to-date gains have been impressive, especially with inflation near 40-year record levels, the recent failure of several large banks both domestically and abroad, and the Fed considering further rate hikes.  So why are markets performing so well?  One reason is that the bond market is betting the Fed will have to start cutting rates sooner rather than later.  The largest driver of the 2022 capital market selloff was the rapid rate of interest rate hikes.  We are now in a period where “bad news is good news.”  Economic data is starting to show signs of slowing, which is causing bond yields to fall (and remember this causes bond prices to go up).  As yields fall, the equity markets are starting to reverse the losses attributed to higher future rates.  This is supported by the outperformance of technology stocks (as seen above in the Nasdaq performance).  The tech sector was impacted most by the threat of higher rates (in 2022 the Nasdaq lost 33%, while the DOW only lost 8.8%).  As you would expect, with the hope of lower rates, tech stocks are unwinding their losses.

What should we expect throughout the rest of 2023?  The market is currently pricing in a 70% chance that the Fed will hike another .25% in May.  Banks appear to have stabilized due to the liquidity measures taken by the Fed (long story short, the Fed has given banks a way to borrow money without having to sell fixed-income securities that are currently priced at a discount).  Inflation is slowing, although still high compared to historical levels.  One very interesting data point is the yield curve inversion.  In this case, the 2 yr treasury yield has been higher than the 10 yr treasury yield since March of 2022.  This is the longest yield curve inversion since the late 1970’s, and has historically been considered a strong predictor of a recession in the near future. 

The factors above hint at possible tailwinds for bonds in the coming quarters.  If the inverted yield curve does in fact presage a coming recession, then the Fed will likely start cutting rates to avoid a deep and proctracted economic contraction.  Conversely, if the Fed does effectively bring down inflation without causing a recession, the lower inflation could lead to lower future rates as well.  Either way it may be an opportune time to consider the bond allocation of your portfolio.  We are currently seeing tax-free, high quality municipal bonds available in the 3.5-4.25% range.  Short-term treasuries are still providing 4-5% yields.  Although no one can precisely predict the next few quarters, it’s possible that we may not see bonds at these levels for long if the market is correct and lower yields are ahead.

Should you have any questions about the markets, specific opportunities, or your portfolio, we highly encourage you to schedule a meeting with your financial advisor today.