- 31st March 2023
- Posted by: Celticfp
- Category: Investment Committee
Markets Rebound from Bank Stress, But Vulnerabilities Remain as Slow-Burn Reduction of Activity Continues
The first quarter of 2023 has come to an end, and despite a rollercoaster ride for investors in March, the month ended on a relatively positive note. For the average UK investor who holds a diversified portfolio of risk-profiled assets, the quarter ended above, or at worst, close to where they started the year, meaning that it was not a “down” quarter after all.
While 2023 has not been as epoch-changing as the Q1 invasion of Ukraine by Russia in 2022, which still casts shadows over the economy and markets, it has still been quite a journey. However, the recent return of a secular growth story, centred on artificial intelligence (AI), has been reassuring to investors. After necessity-driven growth stories in healthcare and carbon reduction, investors like the sense of normalisation and prospects that this new investment path presents.
Bank run fears caused significant angst and downward volatility over March, but the concerns have quickly dissipated, allowing markets to mostly recover into positive territory for the year. However, we should not assume that the episode has passed without any further consequences, as the global financial system’s “immune system” is less strong after each attack. Right now, the “health” of the global economy is fairly vulnerable due to the need to slow to get inflation back under control.
The challenge lies in the fact that the real economy is not yet telling central banks to ease, unlike the months before the 2008 crisis. Western central banks were already cutting rates, and the US Federal Reserve (Fed) started the cycle in September 2007. Now, markets only expect rate cuts (in nine months’ time) because of the expected credit tightening in the aftermath of banking stress, gradually slowing economic growth, and thereby inflation pressures – but not because the economy is already operating below capacity.
The prospect of credit default stress is apparent, but the catalyst to cut rates is not coming from real economy data yet. Vulnerable companies may attempt to shore up their finances, which may lead to further cost cuts in demand, and eventually to job cuts, but there is still little sign of this happening significantly. Indeed, across much of the Western world, the business sentiment indicator, in the form of service sector purchasing manager surveys, has shown a return to growth levels. This week’s Western inflation data beyond the UK has also shown small hints of decline, but only with weaker energy prices factored in. At the core level, second-round effects of last year’s input price shock still saw prices rise as fast or a bit faster than the month before.
All of this suggests that central banks’ squeeze up in interest rates will not come off unless there is another incident that reignites fears of financial instability, which all policy institutions are very keen to avoid. We are therefore left with the slow-burn reduction of activity (and inflation) as we talked about in our outlook for 2023, written just before the year-end.
Everyone is fighting to maintain their own margin, whether it is workers asking for pay rises or companies trying to eke out price rises without losing market share. Interestingly, despite the sharp rise in write-down levels likely to come from March’s bank failures, US write-down levels due to bankruptcy remain at low levels in comparison to financial conditions, indicating a slow burn, rather than a fast cathartic turnaround.
The recovery rally in stock markets tells us that market liquidity remains reasonably healthy. It also appears that the end of the calendar quarter rebalancing has provoked some reluctant buying back of equities to cover underweight positions. Meanwhile, both government and corporate bond markets have already become eerily subdued as the week has drawn to a close.
In conclusion, the first quarter of 2023 may have been challenging, but the markets have shown resilience and recovered into positive territory for the year so far. While challenges remain, investors should remain cautious, stay informed, and make informed decisions. The slow-burn reduction of activity and inflation may not be ideal, but it is a far better alternative than a fast cathartic turnaround, which may cause more harm than good.
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This article is for information purposes only – should not be perceived as financial advice. We recommend you should always speak to a financial adviser before making any investment decisions.
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