Q1 2023 Compass Review

A major crisis. Accommodative monetary policy to save the system.  Lower long-term interest rates. Financial and energy stocks priced for a major recession.  Large cap tech stocks driving the market averages higher.   Was this the summer of 2020 or the first quarter of 2023?

After a rotation away from growth at any cost over the past two years, the Silicon Valley banking crisis signaled a resumption of safety in big tech.  The tech focused Nasdaq rose 17% this quarter, while the S&P500 rose 7%.  Meanwhile, financials were down 6% (in some cases 100%) and energy was down 5%.  

Even prior to the Silicon Valley issues, the past few months were full of anticipation but provided little clarity as to where the economy or world were headed.   This meant that no news was good news for the big five tech stocks that accounted for nearly all the first quarter’s market gain.  The recession should have already arrived, but is now delayed until later in the year according to Wall Street, so why not pile into the few growth stocks left standing after last year’s rout?  Artificial intelligence seems a lot safer than real financial analysis when the world is this uncertain.  

Going into the year there was one thing for certain, the Fed was going to continue to raise interest rates until it broke the back of inflation.  Then came Silicon Valley Bank, which looks like it’s doing a lot of the Fed’s work for them through lower Treasury rates and tighter lending standards.  Now we wait to see whether this banking crisis is contagious or if there can be a soft landing.  

Silicon Valley Bank’s major problem was getting lost in a world of too much money and too much debt combined with poor risk management.  It’s likely they aren’t the only ones who got caught up in the frenzy.  Pick your poison: office real estate, auto loans, the 1,000 private “unicorn” venture companies that are yet to revalue, really anything that relied on cheap money as part of its long-term growth plan.  Will these problems spill over into the larger economy, or can they be contained by restructuring and cost cutting?   

The bond market is still pricing in a Fed rate cut this year, or early next at the latest, which makes sense if there is a recession.  Yet the stock market is priced for business as usual, or at worst, a soft landing.   Soon enough we’ll find out who the winners and losers are. If only we knew ahead of time.

One risk that apparently isn’t priced into markets is the risk of a US debt default as early as this summer if the debt ceiling isn’t raised.  Would politicians really be willing to burn down the house to save it?   They certainly talk like they would.   Maybe it’s one of those things that you can only threaten so many times before nobody takes you seriously, but even if it’s a slight chance of happening, the result would be calamitous.  Maybe we shouldn’t be holding our breath but it’s worth a little concern.

We also wait to see whether the war in Ukraine reaches a bloody stalemate after Russia’s failed winter offensive, or if new arms will allow for enough success to bring Russia to the table.  Nobody knows but the world is waiting.

With so much uncertainty and so much on the line it’s tempting to try to guess the outcomes, but we are reminded of two problems with market forecasting.   First, you have to accurately predict a future event that is not already priced into the market.  Then, you must predict what effect that event will have on markets, which is often quite different than what is anticipated. 

The best course of action in uncertain times is to avoid big bets on any one event or its effect on markets by staying well diversified, holding a little extra cash, and being prepared to take advantage of whatever the markets give us.   Right now, they are giving us reasonable returns on cash and short-term bonds.   Tomorrow, they could give us a great buying opportunity in a variety of industries that will be crushed in the second half of the year if the economy falters.   The key word is could, but we’ll have to see if that shoe drops.

_{Compass Wealth Management LLC is a SEC registered investment advisor, clearing transactions primarily through Pershing Advisor Solutions and Pershing LLC subsidiaries of Bank of New York Mellon Corp. This letter is written by Compass for the benefit of its clients and does not necessarily represent the opinions of its affiliated organizations. It is based on information believed to be reliable, but which is not guaranteed to be correct. Nothing herein shall be construed to be a solicitation to buy or sell securities, indicate that past performance is predictive of future returns, or recommend individual investments.}