U.S. stocks enjoyed a week of strong growth, with major equity indexes registering notable gains during a period characterized by relatively subdued economic data releases and financial news. Small-cap stocks outshined their large-cap counterparts, and value stocks made slightly more progress than growth stocks.
The Nasdaq Composite, dominated by technology companies, soared over 16% in the first quarter of 2023, while the broader S&P 500 Index experienced a respectable 7% increase. However, the more narrowly focused large-cap Dow Jones Industrial Average only saw a modest rise.
Bank stocks, which have suffered significant losses following the collapse of Silicon Valley Bank (SVB) and Signature Bank earlier in March, made a comeback, as the well-known KBW Bank Index surpassed the broader market’s gains.
On Thursday, the Biden administration unveiled a series of proposed regulations targeting mid-size banks – those with assets ranging between USD 100 billion and USD 250 billion. If enacted, these new rules would enforce stricter capital and liquidity requirements and mandate more frequent stress tests for mid-size banks, covering a broader array of market scenarios.
European Shares Rally as Fears of Financial Instability Wane
European shares experienced a rally as concerns over financial instability subsided. Major stock indexes across the continent recorded impressive gains, with France’s CAC 40 Index surging 4.38%, Germany’s DAX growing 4.49%, Italy’s FTSE MIB rising 4.72%, and the Swiss Market Index (SMI) increasing 4.41%. In the U.K., the FTSE 100 Index climbed 3.06%.
European government bonds also saw broad gains as investors assessed the impact of robust core inflation data and hawkish statements from European Central Bank policymakers.
In the U.K., 10-year government bond yields ascended above 3.5% and concluded near that threshold due to heightened anticipation of another interest rate increase in May.
Updated official figures revealed that the country managed to evade a recession last year, partly thanks to government subsidies for energy bills. However, the housing market continued to struggle.
Bank of England (BoE) Governor Andrew Bailey emphasized in a speech that recent issues in the banking sector would not deter the central bank from maintaining its focus on inflation.
Chinese Stocks Advance as Strong Economic Data Boost Confidence
Chinese shares experienced gains as robust economic indicators, and encouraging statements from Beijing strengthened investor faith in China’s growth prospects.
The Shanghai Stock Exchange Index saw a 0.22% increase, while the blue-chip CSI 300 climbed 0.59% in local currency terms. Meanwhile, Hong Kong’s primary Hang Seng Index enjoyed a 2.43% boost.
Newly-appointed Premier Li Qiang emphasized China’s dedication to opening its economy and enacting reforms that could stimulate both consumer spending and international commerce.
Addressing the Boao Forum for Asia, a prestigious four-day gathering for business and government leaders, Li assured that China’s economic revival would invigorate the global economy, even amidst geopolitical challenges.
In a separate development, International Monetary Fund (IMF) Managing Director Kristalina Georgieva predicted that China’s resurgence would contribute to nearly one-third of worldwide growth this year, despite increased economic stability risks due to banking sector turmoil.
The IMF anticipates China’s economy to expand by 5.2% in the current year, while global growth is expected to dip below 3.0%. In the previous year, China recorded a 3.0% GDP growth, which was among the lowest in its history.
In business news, Chinese e-commerce behemoth Alibaba Group unveiled plans to split into six autonomous units, each capable of raising capital or pursuing initial public offerings. Several analysts speculate that this restructuring could placate regulators and potentially signal the conclusion of China’s prolonged clampdown on private enterprise.
However, post-recovery data from China presents a mixed picture. Official manufacturing Purchasing Managers’ Index (PMI) results exceeded expectations, rising to 51.9 in March, while the non-manufacturing PMI reached 58.2 – its highest level since May 2011.
PMI scores above 50 signify growth compared to the previous month. Contrarily, industrial profits plunged 22.9% during the first couple of months of 2023 compared to the previous year, following a 4% decrease in 2022, as reported by the National Bureau of Statistics.
This decline in profits occurred despite earlier data revealing an industrial output rebound during the year’s initial months, suggesting that some manufacturers were reducing prices in response to weak demand.
Latin America Central Banks Tighten Monetary Policy
In an effort to tackle inflation and stabilize their economies, central banks in Latin America have taken decisive action. Colombia’s central bank, for instance, has increased its monetary policy rate from 12.75% to 13.00%, aiming to steer inflation towards its 3.0% target.
Concurrently, Mexico’s central bank has also opted for a hike in the overnight interbank interest rate target by 25 basis points, raising it from 11.00% to 11.25%. This move reflects the bank’s confidence in the economy’s resilience amidst challenging external conditions and a robust labor market.
Nevertheless, policymakers recognize that the balance of risks associated with inflationary trends remains inclined toward the upside.
Market Outlook and Recommendations
As the initial quarter of 2023 wraps up, the stock market has endured a whirlwind of ups and downs. Despite challenges faced by banks, the tech industry’s robust performance ultimately tipped the scales in favor of a positive outcome for the quarter.
Encouraging signs, such as a potential peak in bond yields and the prospect of the Federal Reserve’s tightening campaign drawing to a close, have helped bolster market resilience. While a future recession cannot be ruled out, there are promising indications of recovery, particularly within the technology sector.
The tech industry’s comeback has not only counterbalanced the banking sector’s woes but also prompted a shift in the market’s focus. Consequently, technology and other growth-oriented segments have reestablished their dominant roles in the stock market. The Nasdaq 100, featuring numerous tech giants, posted its best quarter since 2020, rebounding 22% from December lows.
In contrast, small-cap stocks have lagged, primarily due to their increased vulnerability to economic fluctuations and a higher concentration in financials. However, diversified portfolios have benefited from enhanced fixed-income returns, with bonds rising and reestablishing their diversification advantage against equity volatility.
Although the tech sector has made a strong comeback, valuations have recovered, leading to a return to a neutral stance. The consumer discretionary sector now takes center stage, as spending is predicted to remain sturdy even amid decelerating economic growth. A balanced approach between growth and value investments is still advised.
Furthermore, the ongoing banking turbulence may hasten the end of the Fed’s tightening campaign, offering relief to the market as bond yields and policy rates approach their upper limits. While a Fed pause might not assure an end to the bear market, historical patterns suggest that equities could bottom out once the tightening cycle concludes.
As the banking crisis subsides, the market will likely turn its attention to economic data to gauge the potential repercussions of the banking sector’s difficulties.
The main impact would likely stem from stricter lending conditions as banks focus on building liquidity. This could hinder economic growth and heighten recession risks while simultaneously aiding in bringing inflation closer to the Fed’s target.
One area of concern is commercial real estate, where loan refinancing at higher interest rates is set to coincide with elevated office vacancy rates. Regional banks, responsible for approximately 70% of all commercial real estate loans, are expected to tighten financing the most.
While the influence of commercial real estate is relatively minor compared to the broader U.S. economy, monitoring this sector for potential vulnerabilities is essential.
The recent market tranquility does not guarantee an absence of troubling headlines or future strains on bank profitability; however, it does suggest a reduced likelihood of widespread contagion or a structural crisis.
Moreover, the Fed is anticipated to maintain a watchful eye on financial stability concerns and may be approaching the conclusion of its tightening campaign.
The Bottom Line
The stock market’s turbulent journey is expected to continue for a while, but a U-shaped recovery is on the horizon, with the upward curve set to materialize during the latter half of the year.
As inflation begins to ease, the Fed takes a breather, and earnings projections find their footing, investors can utilize dollar-cost averaging to capitalize on market fluctuations.
This approach presents pullbacks as opportunities to strategically align portfolios for a more enduring recovery in the future.