Monthly summary – March 2023

During the latter part of 2022 and in the first two months of this year, bank shares performed strongly on the perception that higher interest rates generally improve bank earnings. However, that view came to a screeching halt when Silicon Valley Bank went under in a matter of a few days and was taken over by the US government’s Federal Deposit Insurance Corporation. The reason, which obviously no one (or very few) saw, was SVB’s liability mismatch which led to a bank run when clients withdrew their deposits. A week later, Credit Suisse, headquartered in Switzerland, met the same fate, albeit for somewhat different reasons, and was taken over by rival UBS in a deal brokered/demanded by the Swiss authorities.

Widespread fears of a 2008 repeat  

Talk of contagion in the financial system made investors fear a 2008 scenario (the global financial crisis) and bank shares fell sharply around the globe. Towards the end of March, the anxiety abated to some extent, even though the related risk of tighter credit conditions added to recession worries.

These events put central banks in a difficult position. Should they go for more interest rate increases to bring inflation down to the two percent target, or hold back in order to stabilize the financial system and mitigate the downward pressure on the economy? The Federal Reserve and the ECB decided to hike, by 25 and 50 basis points respectively, whilst acknowledging the complex issues going forward. Against this uncertain backdrop, market participants started to price in rate cuts later in 2023.

Technology stocks made a remarkable comeback 

Fear didn’t rule the markets unchallenged however, as technology stocks maintained their remarkable comeback this year. After its lackluster development last year, the Nasdaq continued to significantly outperform the broader indices in March. The preference for growth stocks, which had prevailed for most of the last decade, was clearly  back in vogue.

Distress in the financial markets overshadowed other news 

Apart from the woes in the financial markets, little else seemed to attract the interest of the investment community. The war in Ukraine and Russia’s decision to place nuclear missiles in Belarus, plus the increased political tensions between US and China, on top of widespread strikes in France, made very limited impact on investor sentiment.

Somewhat surprisingly world index posted an increase

Even though the news flows and investor sentiment were decidedly negative, the world index in fact posted a slight increase in March after a strong rebound in the second half of the month. Information technology was by far the best performing sector followed by staples, while, on the downside, financials were the obvious losers with energy a distant second. All major markets posted gains with Nasdaq and Japan in the lead, while Europe and Hong Kong noted more modest development.

OUTLOOK

In many ways, the first quarter of the year was both surprising yet typical; a quarter in which last year’s losers gradually made up for some of the previous year’s losses. March continued in this direction but became extra volatile when the banking crisis hit Silicon Valley Bank and Credit Suisse among others. Many experts argued however that the similarities between the current financial stress and the global financial crisis of 2008 are relatively few. This time, they claimed, the value of the banks’ assets (to a significant degree) consists of government bonds and, in addition, they have a higher proportion of equity capital. However, we take note that the interest rate increases have clearly led to contractionary effects in both the financial system and the real economy, and that unknown risks have started to appear, and that this may very well continue.

Crisis caught the Fed by surprise

The Fed was taken by surprise by the magnitude and speed of the crisis among the smaller banks and has ordered an investigation with the aim of examining how their own supervision of financial actors failed and how it can be improved. Additional tightening of the financial regulatory framework is to be expected, and the consequence will likely be a rise in both the cost of the banks’ deposits and bank customers’ borrowing costs.

Healthcare sector out of focus

With sights set on other areas, the healthcare sector is currently no longer in focus. The 2024 election in the US may also mean that some investors might become more cautious and take profits, especially if other sectors, not least the technology sector, show greater strength and higher growth prospects now that the pandemic is over and costs are being reduced. However, many experts wonder if such a stock market rise as we had in the first quarter is sustainable, since they believe forecasted upcoming negative profit revisions will likely affect most industries, including technology.

The outlook for profits, interest rates and inflation are being widely debated at present, and many experienced strategists, economists and well-known investors are currently cautious and even pessimistic; profits will be lower this year, central bank interest rates will likely go higher and, above all, no interest rates cuts are probable in the short term. Many believe that the risk of recession has increased after what happened in the banking sector. In the unlikely event that interest rate cuts were to happen, they might well be viewed as signs of weakness and as a result of rapid decline in demand. Therefore, it is believed that the market strength is coming too early and possibly also in wrong sectors. We choose to be on the cautious side regarding the cacophony of opinions now in circulation but are not overly pessimistic. However, macro factors seem to be coming back into focus. Our main scenario, falling inflation, should give the stock market, we believe, renewed strength.

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