DWM’s 1Q23 Market Commentary: When Do the Ripples Stop…

April 12, 2023

I’m sure we have plenty of boaters in the audience. It’s fun to be out on the water, the fresh air and the smell of the natural surroundings all around. For those that have driven a boat, you know quite well that it’s much different from controlling other vehicles. There are many different styles of boats from small fishing boats to quick ski boats to tall sailboats to full-on giant yachts. I’ve captained a few of them like a pontoon and a cruiser and know of the responsibility invovled. I also know the bigger the craft, the more challenging it can be.

The Fed is basically the captain of a giant yacht, the USS Economy, and lately has been amongst choppy waters. The storms really started brewing when Covid hit. The Fed tried changing directions and steering the USS Economy to a place they thought would be really nice. In fact, in 2021, they reached a destination that was really lovely. Many of the passengers aboard the USS Economy thorougly enjoyed the luxuries on the cruise which witnessed some great market returns. But along with those luxuries came some ripples, aka inflation, and in 2022, the weather turned. Passengers didn’t like what happened next with dreary days more often than not. The Fed then shifted gears and starting raising rates to combat the inflation. They shifted gears and rasied rates more often and at a faster pace than at any other time in history which unfortunately caused even more ripples. One of these ripples came last month and is now known as the mini bank crisis of March 2023 which saw the second and third largest bank failures in US history. The Fed continues to work on beating down inflation while not creating a major recession. In effect, they certainly don’t want to have a vessel the size of the USS Economy careening right through the marina, but are more ripples unavoidable? We’ll get back to answering that and what’s next, but first let’s take a look at how this first quarter fared:

Equities: The SP500 was the biggest wave, up 7.5% for 1Q23. But if you look into the hull, stock performance was really concentrated in just the top 15 “mega-cap” names. In fact, if you look at the remaining 485 names within the SP500, those actually lost value in 1Q23! Small cap underperformed large cap, evidenced by the Russell 2000 Small Cap Index only up 2.7%. And, more importantly, value significantly underperformed growth as one can see in the style box chart below. Why? When the banking crisis hit, it struck the smaller regional banks hard. This bled into the whole financial sector. Financial stocks are typically classified as value hence value suffered. On the flipside, this produced speculation that the Fed would need to cut rates earlier than expected to help prevent further banking crises. Traders moved into mega-cap and tech names that benefit from lower rates, thus the outperformance of larger cap over smaller cap and growth over value. The worst of that banking crisis is most likely behind us; as such, we would expect a bounce-back in many of those beaten down names and thus a reversion to the mean amongst the style box categories.   

Fixed Income: The banking crisis also caused chaos in bond land as its performance has so much to do with the direction of rates. Yields bobbed up and down during the quarter but ultimately sank pretty significantly as seen in the yield curve chart below. When yields go down, bond prices go up as evidenced by the Bloomberg US Aggregate Bond Index producing a 3.0% return for 1Q23. Good to see after such a capsizing 2022.

Alternatives: It was another mixed quarter for alts with the Wilshire Liquid Alternative Index posting a 1.3% return. The big winner of last year, managed futures, went under in the whipsaw 1Q23 environment, down 3.7%*. On the other hand, gold, +7.6%**, shined brightly for its safe-haven-like status in trader land. Real estate, +2.0%*** also bounced back some after a blustery 2022.

To sum up 1Q23, amongst agitated waters, results were quite favorable for the balanced investor. That’s now two decent quarters in a row after the tempestuous start of 2022! 

And amongst some strong currents, we’re at a good spot return-wise as we enter 2Q23, but the ripples are still existent. We are not in a recession right now, but we think we’ll be in one soon. All the pandemic stimulus money has evaporated; further, borrowing is no longer cheap and now much tougher to obtain. And as we’ve repeatedly pointed out before, rate changes usually take about six months to make their effect on the economy. The Fed has never raised rates this much, this fast – the economy is about to feel this impact the same way that a fisherman on the dock is going to feel the USS Economy’s wake. Frankly, we’re hoping we don’t all wind up wet!

The good news is that with inflation, we believe the anchor is coming out and indeed getting under control. In fact, as I write this, just released reports show US inflation falling to its lowest level since May 2021. Further, job growth remains strong. The supply chain has almost completely recovered. And businesses for the most part are quite healthy. Ah, sailors delight…

In conclusion, the sea has been turbulent since the pandemic broke out in 2020 like a tsunami causing all kinds of waves. Everyone must understand that we are still navigating the ripple effects and probably will continue to do so for a while longer. Much like after a crazy day of boating, one can watch the sea from ashore as the ripples simmer down to a state of tranquil peacefulness. This too is possible for the USS Economy if captained correctly. Time will tell if our almighty captain, the Fed, can pull that off, parking this yacht nicely into the marina, or not and slamming right through the dock. Until then and afterward, make sure to have a good wealth management skipper like DWM looking over you and your portfolio. 

Brett M. Detterbeck, CFA, CFP®


* represented by the Credit Suisse Managed Futures Strategy Fund

** represented by the iShares Global REIT ETF

*** represented by the TIAA Real Estate Fund

Detterbeck Wealth Management is a fee-only financial planning / wealth management company with offices located in Palatine, IL (Chicago area) and Charleston, SC areas serving clients locally and across the country. To contact us about setting up an appointment, please see our contact us page