It is hard to believe that the close of the first quarter of 2023 is fast approaching. The year started out on the right foot for investors as January opened with a large rally across the equity space. That buoyancy in the markets turned out to be short-lived, however.
In February, stocks gave back a lot of their gains from the opening stanza of the year. And now in March we have already seen two of biggest bank failures ever recorded in U.S. history. Another financial institution, First Republic Bank (FRC) , also seems to be teetering on the edge, despite last week's injection of $30 billion in deposits from the likes of JP Morgan (JPM) . What can investors look forward to in the second quarter of 2023? Here are some educated guesses.
The Fed Pivots
Since the Federal Reserve embarked on its most aggressive monetary tightening program since the early 80s one year ago, my view, articulated myriad times on these pages, were that rates would continue to be bumped up until something broke. It was only a matter of who would be the Fed's first major casualty and when that would occur. Well, it appears that the country's regional banking system is the answer to that question.
The central bank is now officially between a rock and a hard place, given the events that have transpired since the FDIC shuttered Silicon Valley Bank (SIVB) 10 days ago. Chairman Powell can keep hiking rates until he pushes the economy into a major recession, or the Fed can raise their inflation target. This will mean that costs throughout the economy will remain at elevated levels for longer than hoped. I think the Fed will choose the latter course of action and the likely 25bps boost to the Federal Funds rate this week will be the last one we see for a while.
An Earnings Recession
With continued higher input costs, deteriorating confidence in the banking system and a consumer that has lost buying power due to inflation for 23 straight months now... it is hard to see any earnings growth in 2023. I expect layoffs to accelerate further along with falling consumer confidence in the second quarter.
Downward earnings revisions will happen within numerous industries across the economy, especially cyclical ones like manufacturing. Defensive sectors like healthcare will be less impacted and should be focus areas for investors until this storm ebbs. S&P 500 targets also are likely to be adjusted downward by analyst firms in the coming months.
"You're Gonna Need a Bigger Boat"
Speaking of storms, it is my sincere hope that the recent measures taken by the Treasury Department and FDIC are enough to restore confidence in the banking system. However, it is hard to have a firm belief in that given UBS Group (UBS) just purchased Credit Suisse (CS) in a fire sale in what can only be called a 'shotgun marriage'.
Investors should all fervently hope that Janet Yellen's recent words around the banking system being "stable" don't live on to enjoy the same infamy of Chairman Bernanke's assurances just over 15 years ago that the subprime crisis was "contained." Because if they do, we are going to need a bigger boat and more extreme measures will need to be taken.
I don't see a large possibility that we are heading to a redux of 2008. However, I can't entirely discount the possibility either right now. Until I can, I plan to continue to have half my portfolio in cash and Treasury bills and the rest of my holdings within covered call positions. The most likely scenario I see playing out in the second quarter is that lower entry points will be available for the prudent and patient.