WoodTrust Market Perspectives: Forces at Work

1st Quarter 2023. 

Market Review

Performance Driver Review 

Market Perspectives
In the Fourth Quarter 2022 Market Perspectives, it was noted that expectations for 2023 were cloudy. This “cloudiness” referred to industry experts having a wide range of low confidence market and economic forecasts, but did not even scratch the surface of incorporating what pundits had not yet thought of. As is true during most economic policy transitions, black swans began to rear their ugly head.

For the First Quarter of 2023, this black swan was the exposure of the “yield-greed” that had made its way through a select few regional banks who had managed to elude certain regulatory thresholds. A significant liquidity mismatch between the assets and liabilities on these banks’ balance sheets ultimately required backstopping by the FDIC and U.S. Treasury to ensure the safety of their depositors.

Events like the failure of Silicon Valley Bank remind investors that volatility may not yet be behind them. Much of what has driven volatility over the last 18 months with the disappearance of easy money may also drive volatility on a go-forward basis through the rest of 2023. Positive and negative market and economic forces constantly battle each other to determine market prices; WoodTrust calls this “tension”. Below are the tension points WoodTrust is monitoring while navigating 2023 and beyond.

Positive Forces
The Starting Point
One of the strongest positive forces at work in the markets is the starting point. With higher bond yields than we’ve seen in 15 years and stock valuations around their 15-year average (well off the highs of 2021), public market asset classes broadly are positioned for stronger go-forward long-term performance.

Robust Balance Sheets
Corporate balance sheets remain strong with debt maturity walls generally still a few years out, allowing for adequate reserves to manage through a period of slower spending. The financial situation of consumers is also robust with household debt-to-income levels markedly below historic averages. Both businesses and consumers have room to spend.

Resilient Labor Market
Although there have been some large-scale layoffs at technology companies that invested heavily into their labor forces for the last decade, the unemployment rate remains quite low and most of the “excess” was in job openings instead of payrolls. Steady employment and the Fed’s commitment to pushing inflation back down towards 2% could allow for long-term real income growth potential.

Economic Self-Sufficiency
The U.S. is committed to more economic self-sufficiency as it improves its energy independence and works to onshore supply chains in many sensitive industries. This self-sufficiency should help the country avoid economic contagion from trading partners that come under pressure.

Negative Forces
Unchartered Territory
Made clear by the events of the First Quarter, markets remain in unknown, difficult-to-forecast times. The economic policy shifts of the last 3 years have been historic in nature, and the true cost of these extremes is hard to quantify. Uncertainty tends to hold back both markets and spending.

Rising Interest Rates
Depending on its interpretation of economic activity and inflation, the Fed may continue to increase interest rates. Periods of higher rates tend to incentivize saving over spending and make it significantly more difficult for businesses to expand as high borrowing costs make expansion less economically prudent. Both of these concepts could drag on economic and market performance.

Housing Shock
The housing market is suffering from affordability problems and low supply. Homes often serve as the foundation for middle-class America’s net worth. Without access to this wealth-creation vehicle, long-term wealth potential is impaired and consumer confidence can be eroded along with it.

Exogenous Risks
As noted at the beginning of this Market Perspectives, it is generally not the predictable risks that hurt the market, but instead the risks that no one sees coming. While geopolitical conflict and stress in the regional and European banking systems are known risks weighing on the market, there are sure to be some new black swans that find their way into the headlines as well, possibly pressuring market prices along the way.

In Summary
Just as we warned to start the year, we reiterate that there may be more volatility to come after Q1. Both bull and bear market forces are strong, and until there is a clear victor, we expect dramatic intra-day and intra-week market swings may persist.

Importantly, patience has always been rewarded. Staying invested through the ups and downs of market cycles has been the most consistent way to build wealth over time. The cost of being out of the market when the positive forces take over has historically been quite punitive and the timing of such a turnaround event has been equally as unpredictable. Even after the recent selloff, a patient, 25-year investment in the S&P 500 would have returned an investor 5 times his or her original investment. We believe the next quarter century to be setting up well for additional compounding returns.  As always, we thank you for your trust and look forward to our meetings with you in the near future.