It was a weak February for markets, but they made a comeback in March. U.S. markets were up by low single digits. International markets showed modest gains, with developed markets performing about the same as the U.S. and emerging markets doing slightly better. The news for the quarter was also positive. By some measures, the Nasdaq moved into a bull market, with developed international markets and the S&P 500 also performing well. Overall, it was a stronger start to 2023 than most had anticipated. But is it a positive sign for how the rest of the year will play out? Let’s take a look at the details.
Is Inflation Under Control?
Progress on inflation drove the gains seen during the quarter. Although inflation is still too high, it is well below where it started the year. With the Fed having hiked rates at a fast pace, markets are now convinced that inflation will come under control, as the benchmark yield on the 10-year U.S. Treasury dropped significantly.
The Silicon Valley Bank collapse in March also had an impact on inflation. To be sure, fears of a wider banking crisis rattled markets. Ultimately, however, fast and significant federal actions both resolved the immediate concern and stabilized the system as a whole, by giving banks access to capital to shore up their balance sheets.
That said, those balance sheets remain weak. This weakness suggests that banks will be pulling back through the next year, tightening financial conditions (and doing much of the Fed’s job in controlling inflation). With that in place, markets now expect few if any rate hikes and very likely some cuts this year as the economy slows down.
Economic Slowdown Imminent?
That economic slowdown has not shown up yet, although it is likely to happen soon. The March data, for example, was weaker overall, with job growth and consumer spending pulling back. We are now starting to see signs that rate hikes from last year are acting as a drag on the economy. The bad news is a recession remains possible by the end of the year. The good news? If we do get a recession, it will likely be a mild one.
What Are the Risks?
While the outlook remains positive, of course there are still risks. The evolving banking pullback and political risks are both in play. Here in the U.S., the debt ceiling confrontation is moving closer. Internationally, China remains a wild card. Then there is the OPEC production cut, which is rattling energy markets. And that’s not even considering the risks we don’t yet see. Nothing is guaranteed.
Despite those risks, as we look ahead, the fundamentals are still healthy. We appear to have avoided wider banking system disruption, which is a big positive. Consumer confidence remains at healthy levels, despite everything. So, as long as the jobs market stays strong, any recession (if we get one) should be mild.
The Big Picture
There has been both good and bad news this year, but the good has outweighed the bad. And that sets the stage for how things could keep getting better over the next several months, even in the face of negative news.
The debt ceiling confrontation will be resolved, for example. We will know where we are with a recession. Plus, inflation and rates should improve further. In other words, the risks are real, but we will move past many of them. We are certainly not done with turbulence, but we are in a pretty good place.
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