Week of March 27th, 2023

Key Points for the Week

• The headlines have been bad; yet, stocks have gained over the past two weeks.
• Sentiment has returned to being very negative, which is typically a contrarian sign for the stock market.
• The Federal Reserve raised the federal funds rate by 0.25% at its March meeting.
• Fed members expect credit conditions to tighten.
• Fed members also don’t expect to cut rates this year as inflation remains above their stated goal; that differs greatly from market expectations.

Economic Update

Investors are willing to take on risk to achieve their long-term financial goals, but not everyone manages risk in the same way. Some people are willing to embrace risk, and others prefer a less adventurous option. It is impossible to completely eliminate the risks associated with investing, it is possible to manage investment risk with asset allocation, diversification, and other strategies.

Last week, investors responded to the uncertainty created by bank closures in a variety of ways. Some sold assets they felt had too much risk for the current market environment, opting for sectors and industries that have historically shown resilience during economic slowdowns. Others snapped up investments at discounted prices, reported Ryan Ermey of CNBC. Some investors did nothing.

The smartest thing to do when you have a lot of uncertainty is to sit back and gather information and do your analysis and not jump trying to make big changes.

Source cited by Lu Wang and Isabelle Lee, Bloomberg

Uncertainty is likely to persist as economists and analysts assess how the American economy may be affected.

Banking panics aren’t something to be trifled with. As Fed Chairman Jerome Powell acknowledged on Wednesday, the latest one is sure to slow the economy…The problem, however, isn’t the possibility of more bank failures. It’s that banks are likely to curtail lending—lending they had already started to limit.

Ben Levisohn, Barron’s

As bank lending tightens, economic growth in the United States will probably slow. When it becomes more difficult for households and businesses to get credit, consumer spending tends to fall. Since consumer spending is the primary driver of economic growth in the U.S., the economy is likely to be affected and we may enter a recession, reported Rich Miller of Bloomberg.

Major U.S. indices finished the week higher, while U.S. Treasury yields rose before retreating again.

This Week in the Markets

In the midst of a banking crisis, that has seen some of the largest U.S. banks collapse nearly overnight, and 100-year-old European banks verging on failure, not to mention a volatile bond market and a plunge in crude oil — the Federal Reserve raised rates. While many expected stocks to tumble in the face of such headwinds, it hasn’t happened.

In fact, the S&P 500 has officially gained over the past two weeks despite the banking drama. How could this be? There are certainly more questions than answers right now, and yes, the odds of a recession have increased as banks will tighten lending, which could lead to an economic slowdown. Still, economic data is improving. Housing data is rallying, manufacturing is showing signs of a low, and the consumer is demonstrating incredible resilience.

One of the best reasons to be bullish is very few people are. Recent sentiment polls show a high number of bears while worries about the economy and earnings continue to expand. Why is this a good thing? Think back to March 2003, March 2009, and March 2020. Those were all scary times; yet, stocks made major lows in those years. In 2003, the war in Iraq started after a three-year bear market; the global financial crisis was underway in 2009 and stocks dropped by half; and in 2020 the world shut down due to COVID-19. None of these periods felt like good times to look to a brighter future, but they were.

When investors are bearish, few sellers remain. That means any good news could spark a rally. Potential sparks this time: an increase in FDIC insurance; a Fed that is nearly done hiking; inflation continuing to come back to Earth; stronger earnings from corporate America; a consumer that continues to drive the economy; and the recent banking crisis not expanding past a few badly positioned banks.

Although it might not feel like it, there are many reasons to expect stocks to bounce back and markets to improve.

Banking Stress to Substitute for Rate Hikes

The Federal Reserve raised the federal funds rate by 0.25% at its March meeting, bringing it to the 4.75-5.0% range. This is the ninth straight rate increase and brings rates to their highest level since 2007. However, the most aggressive tightening cycle since the early 1980s, during which the Fed lifted rates from near zero to almost 5%, may be near its end.

Up until early February, Fed officials expected to raise rates to a maximum of about 5.1% and hold them there for a while. However, since that time a slew of strong economic data, including elevated inflation numbers, came in. This pushed Fed officials to give “guidance” that they expected to raise rates by more than they estimated in December.

Market expectations for policy moved accordingly. Prior to February, markets expected the Fed to raise rates to 5% by June and subsequently lower them by about 0.5% by the end of the year. But strong incoming data and Fed guidance pushed expectations higher, with the terminal rate moving up to 5.6% and no cuts in 2023.

The Silicon Valley Bank Crisis Changed Everything

The bank crisis that erupted over the last couple of weeks resulted in a significant shift, both in expectations for policy and the Fed’s actions. See here for our complete rundown on SVB and the ensuing crisis.

Market expectations for Fed policy rates immediately moved lower. Markets expected the stress in banks to translate to tighter credit conditions, which in turn would lead to slower economic growth and lower inflation.

Fed Chair Jerome Powell spoke similarly after the Fed’s March meeting. The 0.25% increase was an attempt to thread the needle between financial stability and fighting inflation. Fed officials also forecast the fed funds rate to hit a maximum of 5.1%, unchanged from their December estimate. This is a marked shift from what was expected just a few weeks ago, with Powell explicitly saying that tighter credit conditions “substitute” for rate hikes.

While the recent bank stresses are expected to tighten credit conditions, and thereby impact economic growth and inflation, a couple questions remain:

• How big will the impact be?
• How long will the impact last?

These are unknown currently, which means future policy is also unknown. Fed officials expect to take rates to 5.1%, i.e., one more rate increase. And they expect to hold it there through the end of the year. In short, they don’t expect rate cuts this year.

Yet, investors expect no more rate increases and about 0.6% of rate cuts in the second half of 2023. Markets expect the policy rate in June to be at 4.8%, while expectations for December are at 4.2%.

There is a huge gulf between what the Fed expects and what investors expect. This will have to reconcile in one of two ways:

• Market expectations move higher — if economic/inflation data remain strong and credit conditions don’t tighten significantly.
• Fed expectations move lower — if the banking sector comes under renewed stress, credit conditions tighten significantly and eventually lead to weaker data.

Events will not unfold in a straight line. It will be a bumpy ride as new data points come in, not to mention news and rumors of renewed problems in the banking sector.

Is There a No-Venting Zone?

When the dangers of secondhand smoke were confirmed, an early solution in many restaurants was the no-smoking section. Now, researchers report that emotions may be contagious. When an expressive friend, family member or stranger shows emotion, it can influence the mood of those around them.

In other words, exposure to positive emotions can invoke happiness and goodwill in others, while negative emotions may spread stress and anxiety.

Over the past decade, we have learned how our brains are hardwired for emotional contagion. Emotions spread via a wireless network of mirror neurons, which are tiny parts of the brain that allow us to empathize with others and understand what they’re feeling…if someone in your visual field is anxious and highly expressive — either verbally or non-verbally — there’s a high likelihood you’ll experience those emotions as well, negatively impacting your brain’s performance.

Shawn Achor and Michelle Gielan, Harvard Business Review

Here's an interesting sidenote: stress can spread by scent, too.

No matter how stress is triggered, there are actions you can take to keep from being overwhelmed by secondhand stress and anxiety. These include:

• Identifying three things you are grateful for,
• Writing a brief email praising someone else,
• Discussing or writing about a positive experience,
• Exercising for half an hour, or
• Meditating for a few minutes.

The research has important implications for the workplace and the home.

2022 IRA and Roth IRA Contribution Reminder

The deadline to make 2022 contributions to your IRA or Roth IRA is April 18, 2023. The total contributions that you can make annually to these accounts cannot be more than the following:

• 2022 maximum allowable IRA and Roth IRA contribution for those 49 and under: $6,000
• 2022 catch up contributions for those 50 and older: $1,000

If you have already contributed the maximum amount allowed for 2022, the total contributions that can be made in 2023 are:

• 2023 maximum allowable IRA and Roth IRA contribution for those 49 and under: $6,500
• 2023 catch up contributions for those 50 and older: $1,000

If you are unsure of how much you have contributed to your IRA or Roth IRA for the year 2022, or would like assistance in opening one of these accounts, please contact us.

Did you Know? This Week in History

March 27, 1912: Japanese Cherry Trees Planted Along the Potomac

In Washington, D.C., Helen Taft, wife of President William Taft, and the Viscountess Chinda, wife of the Japanese ambassador, planted two Yoshino cherry trees on the northern bank of the Potomac River, near the Jefferson Memorial. The event was held in celebration of a gift, by the Japanese government, of 3,020 cherry trees to the U.S. government.

In January 1910, 2,000 Japanese cherry trees arrived in Washington from Japan but had fallen prey to disease during the journey. In response, a private Japanese citizen donated the funds to transport a new batch of trees, and 3,020 trees were taken from the famous collection on the bank of the Arakawa River in Adachi Ward, a suburb of Tokyo. In March 1912, the trees arrived in Washington, and on March 27 the first two trees were planted along the Potomac River’s Tidal Basin in a formal ceremony. The rest of the trees were then planted along the basin, in East Potomac Park, and on the White House grounds.

The blossoming trees proved immediately popular with visitors to Washington’s Mall area, and in 1934 city commissioners sponsored a three-day celebration of the late March blossoming of the trees, which grew into the annual Cherry Blossom Festival. After World War II, cuttings from Washington’s cherry trees were sent back to Japan to restore the Tokyo collection that was decimated by American bombing attacks during the war.

Weekly Focus

For every minute you are angry you lose sixty seconds of happiness.

Ralph Waldo Emerson, Philosopher

If you are lonely when you are alone, then you are in bad company.

Jean-Paul Sartre, Playwright