by Dave Young, President
In the first quarter, the markets brought a welcome change from last year’s bear market. Stocks rallied in January, retreated in February, and then extended their rally last month after a critical measure of inflation cooled slightly. In addition, the recent banking crisis sent investors seeking safety, and Treasuries rose.
After double-digit losses in 2022, most stocks are up for 2023. For the quarter, the S&P 500 gained 7.5%, the Nasdaq rallied 16.8%, and the Dow Jones Industrials added 0.4%. In addition, shares outside the U.S. continued strong; the MSCI EAFE Index, which tracks developed international markets, rose 9.0%.
Our models did an excellent job of staying ahead of the market changes this quarter. Unlike last year, technology led while energy fell behind. You would never know tech is doing well based on their layoffs.
This year Growth stocks did well, while dividend and value stocks lagged. Also, bond yields fell, which is why bond prices increased. This change was a complete reversal from what was working last year. It shows how important it is to stay on top of which areas are outperforming. It is incredible how much of a difference a few months can make.
Our portfolios performed well during the first quarter. Managed Income was up 2.21% versus 2.96% for the Barclays Bond Index. It was impressive that Managed Income only lagged Barclays by 0.75%, considering it beat it by 5.33% in 2022.
In other words, in 2022, Managed Income was structured much differently than the benchmark to beat it by that much. When the market reversed, Managed Income had to make quick adjustments to stay close to the Barclays Bond Index.
Top Flight gained 9.09% for the quarter versus 7.49% for the S&P 500. As always, all of the returns shown are net of all fees. Nate will discuss these and several of our other portfolios in his article. Also, on the last page of the newsletter, we show our long-term performance and disclaimers.
What about the Banks
This situation appeared to come out of nowhere. But, in simple terms, the financial system’s foundation or bedrock is confidence. Without confidence, we are left in a very precarious situation.
We have complete confidence that when we withdraw cash from a bank account or money market fund, or for that matter, close out an account, we will have immediate access to those funds.
But bank vaults aren’t filled with cash that can be quickly repatriated to depositors if, by an incredibly long shot, everyone shows up one day to close their account. So instead, our deposits are invested in high-quality bonds, Treasury bills, and loans.
What happened at Silicon Valley Bank last month was simply an old-fashioned bank run. Why? Confidence quickly evaporated.
But the root cause of its demise had many regulators, investors, and Fed officials scratching their heads because nearly everyone was caught off guard.
Unlike 2008, when major banks were saddled with bad real estate loans, SVB invested heavily in a portfolio of high-quality, longer-term Treasury bonds. From a credit standpoint, these are super-safe investments. What could go wrong?
Well, nothing if the bonds were held to maturity or if interest rates had remained stable. Bond prices and bond yields move in the opposite direction. When yields rose, the bonds fell in value, creating a paper loss.
But its customer base of venture capital investors had been drawing down on their deposits as more traditional funding sources were drying up. With deposits being drawn down, SVB was forced to sell $21 Billion in bonds, and the bank took a nearly $2.0 billion loss. In addition, SVB’s hastily announced a plan to raise capital was quickly scuttled when its stock tumbled, and depositors quickly began to withdraw cash since a large majority of the bank’s deposits were above the FDIC limit.
Less than two days after the bank revealed its loss on the sale of Treasuries, on March 10th, regulators were forced to shut it down. Next, Signature Bank, heavily into cryptocurrency, was closed on Sunday, March 12th. SVB and Signature were the second and third-largest bank failures in U.S. history, respectively.
Regulators did not have the time to line up buyers, and the FDIC moved to guarantee all bank deposits of the two failed banks. It’s difficult to estimate the carnage we might have seen on Monday morning, but the plan to stabilize the banks with deposit guarantees and a new lending facility from the FED helped contain the crisis and prevent contagion.
The new lending program from the Fed enables banks with high-quality bonds to borrow against the full value (par value, not current value) of their bonds, using the bonds as collateral. In theory, there is no need to sell the bonds.
Banks such as SVB piled into high-quality, long-term bonds but didn’t hedge against the possibility of a rapid rise in interest rates. Rising interest rates exposed a fatal flaw in its portfolio. This crisis might do the Fed’s job, as tighter lending standards slow economic growth. Inflation has yet to be squashed, but problems with SVB have not spread to other banks. The crisis eased as the month ended, and most of the assets of the failed banks were purchased.
Recently, sentiment has shifted on rates, but the sentiment is ever-shifting. So how the Fed reacts this year will depend on economic performance. As the month came to a close, fears waned, helping shares rally, and the month ended on an optimistic note. It will take time will tell whether this unprecedented move to bail out these two banks was a good idea or not.
These are unusual times. Our government’s reaction to Covid completely turned our economy upside down. Since it began, the FED has committed $4.7 Trillion, Congress authorized an additional $6.0 Trillion, and the Executive Branch approved another $1.0 Trillion.
So far, a total of $11.7 Trillion has gone or is going into our economy. $11,700,000,000,000. Depending on how you look at it, $11,700 billion or $11,700,000 million.
If you are a visual person, placed end to end, the dollar bills will go 30,202 miles. For reference, the earth is 24,901 miles around at the equator. Understanding just how much money our government has spent should help you understand why inflation is the highest in forty years.
When people ask me where the markets are going next, I tell them I’m not sure. This is the first time I’ve seen this much money borrowed and spent by our government. So I can make a very positive bullish case for our economy or a negative bearish case.
At this point, we need more information. Over the past 36 years I’ve been doing this, we have been through all kinds of crazy economic situations. Our solution is always to continue to monitor the markets and follow our models.
Knowing which way to turn can be challenging when so much is in flux. So rather than trying to guess what might happen next, focus on what you can control. Focus on your goals and objectives, stay on track with your investments and enjoy your life.
As always, we are honored that you have allowed us to serve as your financial advisors. Please reach out if you have any questions or concerns.