Investors had lots to cheer by the end of Q1 as stocks rallied, bond yields fell, central bank hiking slowed, and inflation cooled again. It’s a promising start to 2023, but there were a few shocks along the way. Equity markets dipped in February over concerns “hot” economic data coming in might mean Fed interest rates have to stay higher for longer. Then in mid-march, there was a scare as U.S. regional banks Silicon Valley Bank and Signature Bank were forced to close, which dragged down banking stocks. The fallout spread overseas, affecting Credit Suisse. However, following a coordinated response by central banks to maintain market functionality, liquidity and protect deposits, Canadian, U.S. and global equities recovered to wrap up Q1 with impressive gains. The tech sector led the way, offsetting banking volatility.
It was also a bright beginning to 2023 for bond markets as prices rose and yields fell on more signs inflation was easing and, as a result, lower expectations for interest rates. There were several market-friendly Canadian and U.S. economic indicators during the quarter. Job creation on both sides of the border continued to be resilient. Canadian retail sales rose, and home sales slowed, while U.S. GDP grew by 2.7%. There was promising economic news overseas as well. Surveys of manufacturers, the services sector and consumer sentiment in the U.K. and the eurozone revealed an improved outlook and an easing of supply chains. Economic activity is also picking up in China as it reopens for business after lifting its “zero-covid policy” pandemic restrictions. Chinese manufacturing, in particular, moved back into expansionary territory, which global markets responded to positively.
The Canadian federal government released its 2023 annual budget at the end of March. Highlights included health and dental care spending, green initiatives, and a grocery tax rebate. It also featured proposals to raise the alternative minimum tax rate and threshold and increase limits for some RESP withdrawals.
U.S. inflation cooled for the third consecutive quarter, from 7.1% to 6%, as prices for goods and energy continued to stabilize. This was still higher than hoped due to increased food and housing costs, but the underlying details remain consistent with trending disinflation. As a result, the Fed raised its target interest rate by a smaller 25 basis points twice during Q1, from 4.5% to 4.75% in February and to 5% in March. Fed chair Powell indicated the end of its tightening cycle is near, adding a soft landing for the U.S. economy, as opposed to a recession, is still attainable. However, he also stressed the Fed would be prepared to increase rates further if tighter financial conditions do not effectively slow economic activity.
Inflation also moderated in Canada, from 6.8% to 5.2%, the most considerable deceleration since April 2020. Statistics Canada said this was mainly due to lower gasoline prices, although grocery and mortgage interest costs continued to rise. The Bank of Canada raised its benchmark rate from 0.25% to 4.50% in January. Bank governor Macklem then indicated rate hikes would be on hold to assess the effects of hiking so far. He added that the bank would hike again if needed to get inflation back to the 2% target.
Capital Markets in Q1
The S&P/TSX Composite Index ended the quarter up 3.7%, the S&P 500
Index up 7%, the MSCI EAFE Index up 4.5% and the MSCI World Index
up 7%.
Markets rose through January before dipping in February over concerns economic data pointed to a still too strong underlying economy which might prolong central bank rate hiking. Then in mid-march, there was a scare as U.S. regional banks Silicon Valley Bank and Signature Bank were shut down, which dragged down banking stocks. The fallout spreadoverseas, affecting Credit Suisse. However, following a coordinated response by central banks to maintain market functionality, liquidity and guarantee deposits, Canadian, U.S. and global equities recovered to end Q1 strongly. The tech sector was the leading quarterly contributor, offsetting banking volatility, with the Nasdaq, in particular, having its best quarter since Q2, 2020, rising approximately 17%.
Several major U.S. banks also posted quarterly earnings, which were overall quite strong. Canadian banks also had another round of solid results, primarily driven by their trading businesses.
Like equities, bonds see-sawed through Q1. In January, bond yields fell on more signs inflation is easing. Then in February, yields rose in negative correlation to equities before falling again on lower expectations for how high the Fed would hike rates following the Silicon Valley Bank and Signature Bank closures.
An academic, Kazuo Ueda, was also named the new Bank of Japan head over existing deputy governors, potentially indicating a change in Japan’s near-zero rate policy, which could impact global bonds.
The price of oil fell steadily through the quarter. Optimism over China reopening was countered by the March banking scare, Fed chair Powell stating the Fed would increase rates further if required and concerns about a potential U.S. economic slowdown. Other contributing factors included a slower-than-expected recovery in international travel and a
continued Russian supply despite Western sanctions. Oil rose about 9% in the last week of March, stemming from disruptions to Iraqi exports. The loonie dubbed a “petro-dollar” due to its close ties with the oil sector, strengthened against the greenback throughout March but for the entire quarter was virtually unchanged.
What can we expect now?
The recent banking troubles have likely been contained thanks to a swift response from central banks. However, the probability of a global economic slowdown has risen due to tightening credit conditions, which should lead to decreased spending and lower prices. The rate increases over the last year have had a delayed impact and continue to impact the economy and monetary policy decisions. The likelihood of interest rates moving lower by the end of 2023 is increasing, potentially setting the stage for the next bull market.
Regardless of where we are in the market cycle, a disciplined investing approach and staying focused on your long-term goals is crucial. This strategy helps you keep your emotions out of investing, typically buying high and selling low, as many investors do. Ongoing monitoring and reviewing of your portfolio also ensure it remains on track. Diversifying investments reduces risk as well.
We are here to help you achieve your financial goals. Should you have any questions, please do not hesitate to contact your NPW Advisor.
