U.S. equities were higher this week, as the S&P 500 and Nasdaq rose for a second straight week. Equity markets varied widely as banking industry and recession worries weighed on stocks. Growth outperformed value. The technology-heavy Nasdaq Composite outperformed the small-cap Russell 2000 Index by approximately 8.3%. Relatedly, financials underperformed for a third consecutive week, and the real estate sector declined due to worries about how stresses in the regional banking system would affect the commercial real market, where regional banks are the primary lenders. Finally large-cap growth stocks benefited from falling interest rates.
Shares in Europe ended in positive territory, despite weakness in bank stocks. In euro terms, the blue-chip EURO STOXX 50 and the STOXX Europe 600 Index ended1.61% and 0.87% higher, respectively. Bank stocks in the STOXX Europe 600 Index resumed their downfall at the end of the week on worries over the health of the financial sector. The slide reversed earlier gains on the news that UBS Group agreed to buy Credit Suisse in a deal arranged by the Swiss authorities. The Bank of England raised interest rates to 4.25% from 4.00%, for the 11th consecutive increase as consumer prices rose to 10.4% in February—well above the consensus expectation. According to the Financial Policy Committee UK banking system maintains robust capital and strong liquidity positions," and "that the UK banking system remains resilient."
Japan’s stock markets generated mixed returns for the week, with the Nikkei 225 Index gaining 0.19% and the broader TOPIX down 0.21%. Chinese stocks rose as investors expect China’s central bank to maintain an accommodative policy due the global banking turmoil. The Shanghai Stock Exchange Index gained 0.46% in local currency terms. In Hong Kong, the benchmark Hang Seng Index added 2.03%.
As it was expected, the Federal Reserve unanimously raised the Fed funds target rate by another 25 basis points to 4.75%–5.00% on Wednesday, while acknowledging that problems in the banking system triggered by its previous rate increases are likely to weigh on the economy. This is the second consecutive meeting in which the Fed has hiked rates by 25 bps. Analysts expect the Fed to remain data dependent, as the recent February inflation report shows that inflation is starting to ease but it is substantially higher to the Fed’s 2% target. The market expectations, the “dot plot”, shows that the FED will to stop raising rates after one more hike in May. References to ongoing rate increases were also removed from the official statement. Despite economic uncertainty the Fed’s is committed to fight inflation by moving policy rates to a restrictive level and holding them there until inflation starts moving closer to 2% target.
The Fed did say the banking system is resilient, and we believe it. Furthermore, banks are better capitalized, and there are more tools at policymakers’ disposal to keep banks and financial markets stabilized. This gives certain confidence to the market that while volatility in the banking sector will remain elevated, there are tools to help mitigate any further risks to financial stability.
Last week’s economic data show that the economy still had significant strength. Weekly jobless claims remained near five-decade lows, adding 311K jobs in February after adding over 500K jobs in January. According to Bloomberg, since October 2022, the technology sector has suffered job losses, and the consumer discretionary sector has had the second-most layoffs. On the other hand, certain sectors of the economy are currently booming, over a third of the job openings are in retail, leisure and hospitality, and education and health services. The S&P Global’s Composite Index of both current services and manufacturing activity, released Friday, jumped from 50.1 to 53.3 (with readings of 50 and over indicating expansion), indicating the fastest pace of private sector growth since last May, with new orders turning higher for the first time since September. According to S&P Global’s chief economist, the data were “broadly consistent with annualized gross domestic product (GDP) growth approaching 2%. Data regarding core capital goods orders, which exclude orders for aircraft and defense, an indication of business investment, also surprised to the upside when released by the Commerce Department on Friday. Such orders increased in February by 0.2%, beating a Bloomberg survey estimate.
The bond market has also seen increased volatility. In one month, the 2-year U.S. Treasury yield has gone from a high of 5.1% to around 3.8%. The downward pressure on yields came as investors seek safe-haven assets like government bonds and as the market expect the Fed will cut rates by the end of this year. Analysts see opportunities with longer-duration bonds, particularly in the investment-grade space. These bonds not only lock in better yields for longer, but also have the opportunity for price appreciation, especially if the Fed does pause and, over time, move interest rates lower.
In our view, the Fed is certainly close to the end of its tightening cycle, yields will eventually stabilize. Perhaps the highs in yields are behind us.
Volatility will persist near-term, but opportunities are forming in both equities and bonds. We remain defensive in our positioning, and we’d look for opportunities to upgrade portfolios during market weakness. Within equities, we continue to favor U.S. Large Cap exposure. It is important to remember that markets are forward-looking: they may not wait until the Fed has officially pivoted lower, or for the economic data to officially bottom before stocks and bonds start to price a recovery.
We’ve recently become more constructive on International equities, as the energy recession wasn’t as severe as anticipated. In the United States, large-cap equities provide an attractive blend of quality, yield and growth at a reasonable value, even at a little high higher valuations. We remain defensive in our credit positioning, with at benchmark duration, and higher in credit quality.