The stock market displayed resilience in the first quarter of 2023, even as earnings forecasts for this year modestly declined. For the quarter, the S&P 500 Index was up 7.5%. At the beginning of 2023, earnings were expected to grow by low single digits by the end of the year.
Today, 2023 earnings are expected to be down slightly from 2022. Yet, the growth sectors of the economy are dominating like it’s 1999! Year-to-date through March 31, 2023, Information Technology is up 22%, Communication Services 21%, and Consumer Discretionary 16%. Defensives and cyclicals are slightly up or modestly lower. Financials is the worst sector down 6% reflecting the current banking tumult.
It appears investors have been solely focused on interest rates as the dominant factor in equity positioning. Expectations are high for an end to the hiking cycle in the next quarter.
Since the Silicon Valley Bank failure led to a banking crisis in early March, expectations have risen for rate CUTS toward the end of the year. Let’s forget for a moment that EVERYONE has gotten the rate hike cycle wrong so far.
Going into 2022, the Federal Reserve (Fed) was expected to move the Fed funds rate higher by 75 basis points from zero starting in July through December. Instead, the Fed started increasing rates in March, sooner than expected, and ultimately raised interest rates 425 basis points. So far in 2023, the Fed has increased rates by another 50 basis points to 4.75%. ALL forecasts from early 2022 were significantly wrong.
Why would we think everyone (or anyone?) is right about forecasting future interest rates with any precision this time? Just like last year, it may well play out differently from the consensus forecast. Even if the Fed doesn’t raise again and then lowers rates 75 basis points in the second half of this year, the Fed funds rate would be at 4.00%, still VERY high compared to any rate environment we’ve had in the last decade.
In our view, investors need to temper expectations for future returns. A world of “higher for longer” rates and slower growth than the last several years is much more likely than a return to the abnormally low interest rate environment where long duration growth stocks dominated and high valuations were accepted. With that in mind, updates to portfolios in Q2 include:
- Continue to increase portfolio exposure to fixed income, moving to overweight in intermediate maturity bonds, favoring corporate credit
- Maintain neutral to slightly underweight U.S. equity, in anticipation of a mild recession and lackluster returns for the rest of the year
- Move to overweight international equity, due to 1) attractive valuations 2) higher dividends 3) better earnings growth and 4) continued U.S. Dollar weakness
We will continue to carefully monitor market developments and welcome the opportunity to speak with clients in more detail about portfolio strategies.