Executive Summary
- The S&P 500 gained 7.5% for the second consecutive quarter
- Rates volatility soared to near 15-year highs on the fallout from banking turmoil
- Regional Banks recorded the deepest oversold reading on record
- Semiconductors rallied for 2nd best quarterly performance in 22 years
- Federal Reserve balancing inflation versus financial stability
- Crude oil surged on unexpected production cut announcements by OPEC+
March was a volatile month for the capital markets as the Federal Reserve’s now 13-month rate hike cycle contributed to stresses in the banking system resulting in the closing of three regional banks, a forced takeover of Credit Suisse, government deposit backstops, and a new special lending facility for banks.
Equities were mixed, with regional banks receiving the brunt of the selling pressure. The KRE Regional Bank ETF declined more than 27% in less than three sessions for its worst 3-day selloff since inception in 2006 before finishing near the bottom of the month’s range. Its daily relative strength index (RSI), a measure of momentum, reached its deepest “oversold” reading (11.6) on record. Investors found safety in precious metals and miners, large-cap growth, and defensive groups, while small caps from nearly all sectors (9/11) finished lower in March.
While volatility was extreme within select equity groups, mainly banks, the VIX Index was relatively tame. Its highest close in March was 26.52 while having only three daily closes above 25 before closing the month below 19.
Volatility was most profound within the rates complex, particularly in the belly of the curve. The 2-5 year UST yields had their biggest weekly decline since the 9/11 terrorist attacks in 2001, while the MOVE Index reached its highest level since the peak of the Financial Crisis in Q4 2008. The entire 2s-30s UST yield curve is trading below Fed Funds, and it has been exactly one year since the 2s-10s UST spread first inverted. The trough in the 2s-10s spread (-108 bps) was reached on March 8, which coincided with Chair Powell’s semi-annual Congressional testimony where he was then correcting his “disinflation” emphasis and second straight decelerating rate hike at the prior February FOMC.
The Nasdaq-100 (NDX) led the majors with a total return of 9.5% in March. For Q1, the NDX gained 20.8% marking its best first quarter since 2012. The S&P 500 and Dow Jones Industrials finished with strong monthly gains of 3.7% and 2.1%, respectively. For the second consecutive quarter, the S&P 500 gained 7.5%. According to Carson Investment Research, the S&P 500 has never finished the full year lower when up more than 7% in Q1 (sample = 16). And of the prior 23 times, it gained more than 5% in two consecutive quarters; one year later, it finished higher 20 times with an average gain of 13.5%. The smaller cap S&P Midcap 400 and Russell 2000 declined 3.2% and 4.8%, respectively.
Sector performance varied widely between large and small caps. Seven of the eleven S&P 500 large-cap sectors were higher, led by Technology (+10.9%) and Communications (10.4%). Technology gained 21.8% in Q1, led by the semiconductor industry, where the SOX Index had its best quarter (+28%) since June 2020 and second best in 22 years. Next were the defensive Utilities and Staples sectors, with monthly gains of +4.9% and +4.2%, respectively, while on the other end, Financials declined 9.6%. Notably, the Industrials sector is less than 3% from 52-week highs.
In the final week of March, the SOX Index broke out from an 8-week consolidation range before closing at its highest level since early April 2022.
At the small-cap level, nine of eleven sectors finished in the red, with only Utilities (+1.3%) and Technology (+1.1%) finishing higher. Notably, in Q1, the small-cap Russell 2000 Technology Index underperformed the large-cap S&P 500 Technology Index by the widest margin in nearly 23 years (July 2002).
The banking turmoil whipsawed the rates market, which in early March had just been coming around to the Fed’s higher for longer guidance. That hawkish outlook changed on a dime, and the Fed Funds market quickly began pricing rate cuts as early as July. In under three sessions, the rate on the November contract declined more than 185 bps. Recent market stability and sticky inflation data have led to a rebound in rates while pushing the highest probability for the first rate cut out to September or November; however, the environment remains fluid.
The sharp fall in rates was led by the UST 2yr yield, which initially declined 122bps in under three sessions, and as much as 153 bps from its March high of 5.08% to a low of 3.55% before rebounding to a monthly close at 4.03%. The longer UST 10yr yield declined as much as 81 bps to a low of 3.28% before rebounding to 3.47% at month’s end. The 2s-10s UST spread widened (bull steepener) from a low of -108 bps to -59 bps.
WTI crude was down more than 16% to 15-month lows before an end-of-month surge left it with a monthly decline of just 1.8%. While crude has finished lower in nine of the prior ten months, over the weekend, it surged as much as 8% after OPEC+ unexpectedly announced production cuts that will exceed 1 million barrels per day, led by Saudi Arabia with 500,000 barrels. Higher energy prices are not only a headache for the Federal Reserve in its fight against inflation, but it is also a headache for the administration as the Strategic Petroleum Reserve is down 222 million barrels (594M to 372M) since the start of 2022 (15 months).
Precious metals finished higher, with spot gold and silver +7.8% and +15.2%, respectively. Gold closed the month at $1,969, which puts it back above its 2011 highs and within 6% of new all-time highs. The U.S. Dollar Index (DXY) was down 2.3% in March for its fifth decline in six months.
Looking Ahead
Banks stocks are at historically low valuations, but the upcoming Q1 earnings season could allow managements and investors to quantify and address some of the concerns surrounding an FDIC assessment, liquidity and duration risks, deposit betas, and future legislation. For the S&P 500, the estimated Q1 2023 earnings decline is -6.6%, which would mark the largest decline since Q2 2020, according to FactSet. Over the course of Q1, the bottom-up EPS estimate for the calendar year 2023 declined by 3.8% to $221.50 from $230.33. The S&P 500’s forward 12-month P/E is 17.8, which is below the 5-year average of 18.5 and above the 10-year average of 17.3.
Stresses in the U.S. banking system have led to a conundrum for regulators who are aiming to balance tensions between price stability and financial stability. Last month the Federal Reserve pushed forward with another 25bp rate hike, totaling the equivalent of 19 25bp rate hikes in just 12 months. Chair Jerome Powell emphasized the U.S. banking system is sound but also made it clear his committee is incorporating real economic impact from the banking stress via the lending channel. The probability for another 25bp rate hike is currently 55% – 65%, but more importantly, the conversation is shifting to WHEN and HOW FAST the Fed will begin cutting rates. Their most summary of economic projections sees rates elevated around 5% through the end of 2023. How markets will then react will largely depend upon the context driving the upcoming rate-cut cycle.
The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. All information contained herein is obtained by Nasdaq from sources believed by Nasdaq to be accurate and reliable. However, all information is provided “as is” without warranty of any kind. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
