Market Observations: February 2023 Recap
- March 14, 2023
Financial markets gave back some of January’s gains in February as equities fell and interest rates rose. The S&P 500, MSCI EAFE and MSCI EM indices fell -2.4%, -2.1% and -6.5%, respectively, during the month. The strength of the economy, highlighted by the expectations-exceeding 517,000 jobs added in January, and the troubling trend reversal of Core PCE, the Fed’s preferred inflation gauge, sent yields on all maturities higher. The yield on the 10-year U.S. Treasury increased by 0.40% to end the month yielding 3.92%. The closely followed 2yr/10yr yield spread extended its inversion to -0.89% at the end of February before exceeding -1.00% in March, reaching the greatest levels since 1981. The expanding yield inversion is an indication that the market increasingly expects economic growth to slow in the future.
Amidst meaningful declines in inflation during Q4 2022, the market increasingly expressed a relatively sanguine outlook for the path of inflation to converge to the Fed’s 2% target rate. This view was challenged as the trend of the Fed’s preferred inflation gauge, Core PCE, flipped in January. While the market expected Core PCE to drop from December’s 4.6% to 4.4% in January, the reported data came in at 4.7%.
As an investor, management team or policymaker, it is easy to fall into the extrapolation trap and assume that a line on a chart, whether representing asset prices, earnings, inflation or something else, will continue on its current path. The pitfall of this momentum-based reasoning is that trend reversals can happen suddenly and in drastic fashion. This concept is the basis for the old stock market joke, ‘stocks take the escalator up but the elevator down.’
Last week provided an extreme example of the risks of extrapolation-driven decision making with the failure of Silicon Valley Bank (SVB), the second largest bank failure in U.S. history. After years of very strong venture capital (VC) industry-driven deposit growth coupled with low and stable interest rates, balance sheet and risk management decisions were made that in hindsight appear incredibly naïve. Over the last year or so, VC-backed start-up company cash balances peaked and then steadily declined as the capital raising environment grew increasingly challenging in the higher interest rate environment. Deposit balances fell as VC-backed companies utilized the capital to fund business growth and pay employees. The significance of this trend was unique to SVB due to its central role in the VC funding ecosystem and its concentrated depositor base. It is estimated that half of all VCbacked start-ups banked with SVB. As SVB’s deposits were dropping, so too were the value of its interest rate sensitive assets. On Wednesday, SVB announced that it sold $21bn of securities, which had an average yield of just 1.79%, at a loss of $1.8bn. This action was taken to raise cash and reduce its balance sheet’s sensitivity to higher interest rates. This created a problem as a strong balance sheet and the perception of a strong balance sheet are paramount to a bank’s continued operations. On Thursday, the bank’s management team announced an attempted $2.25bn capital raise to fortify its balance sheet as the bank’s CEO urged clients and investors to ‘stay calm.’ Instead of achieving the intended goal of reassuring its banking relationships and equity investors, it triggered an old fashioned bank run. On that day alone, depositors requested withdrawals of approximately $42bn, representing nearly 25% of deposits, and the equity price fell 60%. Bank management pivoted to an attempted sale before the bank was declared insolvent and placed under FDIC receivership, wiping out the equity value on Friday. All of this occurred within 48 hours.
On Sunday evening, multiple government agencies jointly announced a plan to backstop depositors in an attempt to stem the risk of systemic contagion.
Over the coming months, I plan to write about the extrapolation and learned response of economic conditions and the potential impact of changing environments on asset portfolios.
Summary of key points that occurred in the markets globally during the month.
US Equity Summary:
The S&P 500 returned -2.4% for the month and the year-to-date return ended the month 3.7%.
Small and mid-cap slightly outperformed large cap equity.
Growth outperformed value across all market cap segments according to the Russell style indices.
The majority of S&P 500 sectors generated negative returns for the month, as only Information Technology generated a positive return. Information Technology, Industrials and Consumer Discretionary were the top performing sectors. Energy, Real Estate and Utilities were the weakest performing sectors.
Quarterly S&P 500 earnings growth was -4.6% (blend of reported and estimates) with 99% of companies reported. Of the reporting companies, 69% reported positive earnings surprises.
From a factor perspective, Quality, Growth and Dividend Aristocrats performed the best. Pure Value, High Dividend and Low Volatility High Dividend fared the worst.
Developed and Emerging Market Equity Summary:
The MSCI EAFE Index returned -2.1% for the month, outperforming the MSCI EM Index, which returned -6.5%.
The large cap segment underperformed within emerging markets while performance was mixed across market cap segments within international developed markets.
Energy, Industrials and Financials were the top performing international equity sectors. Materials, Real Estate and Information Technology were the weakest performing sectors.
Information Technology, Consumer Staples and Financials were the top performing emerging market equity sectors. Consumer Discretionary, Utilities and Healthcare were the weakest performing sectors.
Frontier markets outperformed emerging markets, as the MSCI Frontier Markets Index returned -2.5%.
From a factor perspective within international market equities, Diversified Multi-Factor, Enhanced Value and Momentum performed the best, while Quality, High Dividend Yield and Minimum Volatility performed the worst. Within emerging markets, Minimum Volatility, High Dividend Yield and Quality fared the best, while Diversified Multi-Factor, Momentum and Value Weighted were the laggards.
Fixed Income Summary:
The Treasury rate curve rose and further inverted during the month. Yields on all maturities ended the month higher.
The 10-year Treasury bond declined during the month as yields rose and ended the month yielding 3.92%, a 0.40% increase from where it began the month yielding 3.52%.
The greatest increase in yields occurred with the 3-year maturity, which increased by 0.61%. The yields on the 4-month through 30-year maturities rose by at least 0.26%. The closely followed 2yr/10yr yield spread further inverted and ended the month at -0.89% and the inversion in March has exceeded -1.00%, reaching the greatest levels since 1981.
Investment grade credit generated negative returns, posting a -3.0% return as per the Bloomberg U.S. Credit Index.
High yield spreads tightened during the month as the Bloomberg U.S. Corporate High Yield Index fell -1.3%.
The broad Bloomberg Global Aggregate Bond Index posted a -3.3% return for the month.
Municipal bonds declined -2.3% as per the Bloomberg Municipal Bond Index, with the high yield segment down -3.1%.
Non-U.S. hard currency sovereign bonds were down -4.1% as per the FTSE WGBI Non-USD. Emerging market corporate debt (JPM CEMBI Broad Diversified) and local currency denominated sovereign debt (JPM GBI-EM Diversified Composite) declined during the month.
The U.S. Dollar index was up 2.7% for the month.
Indices are unmanaged and presented for comparison purposes only. Please note that the returns displayed for indices do not take into account any of the costs associated with buying and selling individual securities. Individuals cannot invest directly in an index.
Bloomberg Barclays Capital U.S. Aggregate Bond Index: The U.S. Aggregate Index covers the USD-denominated, investment-grade, fixed-rate, taxable bond market of SEC-registered securities. The Index includes bonds from the Treasury,Government-Related, Corporate, MBS (agency fixed-rate and hybrid ARM pass throughs), ABS, and CMBS sectors. The U.S. Aggregate Index is a component of the U.S. Universal Index in its entirety. The index was created in 1986 with index history backfilled to January 1, 1976. All issues in the Aggregate Index are rated Baaa3/BBB-/BBB- or higher (using the middle rating of Moody’s, S&P, and Fitch, respectively) and have at least one year to maturity and have an outstanding par value of at least $250 million.
Bloomberg Barclays CMBS IG TR USD: The index measures the performance of investment-grade commercial mortgagebacked securities, which are classes of securities that represent interests in pools of commercial mortgages. The index includes only CMBS that are Employee Retirement Income Security Act of 1974, which will deem ERISA eligible the certificates with the first priority of principal repayment, as long as certain conditions are met, including the requirement that the certificates be rated in one of the three highest rating categories by Fitch, Inc., Moody’s Investors Services or Standard & Poor’s.
Bloomberg Barclays Municipal TR USD: The Bloomberg Barclays Municipal Bond Index is considered representative of the broad market for investment grade, tax-exempt bonds with a maturity of at least one year.
Bloomberg Barclays US Corp IG TR USD: The index measures the performance of investment grade corporate bonds.
Bloomberg Barclays US Corporate High Yield TR USD: Bloomberg Barclays US Corporate High Yield TR USD
Bloomberg Barclays US Govt/Credit Interm TR USD: A subgroup of the Bloomberg Barclays Government/Credit Bond Index that is based on maturity with greater than 1 to 10 years.
Bloomberg Barclays US Govt/Credit TR USD: The U.S. Government/Credit Bond Index is the non-securitized component of the U.S. Aggregate Index. Specifically, the Government/Credit Index includes treasuries (i.e., public obligations of the US Treasury that have remaining maturities of more than 1 year), Government-Related issues (i.e. agency, sovereign, supranational, and local authority debt) and Corporates ( publicly issued US corporate and Yankee debentures and secured notes that meet specified maturity, liquidity, and quality requirements). All issues in the Government/Credit Index are rated Baaa3/BBB-/BBB- or higher (using the middle rating of Moody’s, S&P, and Fitch, respectively) and have at least one year to maturity and have an outstanding par value of at least $250 million.
Bloomberg Barclays US MBS TR USD: The Bloomberg Barclays Mortgage-backed Securities Index is a market valueweighted index which covers the mortgage-backed securities component of the Bloomberg Barclays U.S. Aggregate Bond Index. The index is composed of agency mortgage-backed pass through securities of the Government National Mortgage Association (Ginnie Mae), the Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (Freddie Mac) with a minimum $150 million par amount outstanding and a weighted-average maturity of at least 1 year. The index includes reinvestment of income
Bloomberg Barclays US Treasury 1-3 Yr TR USD: The Bloomberg Barclays Capital US Treasury Bond 1-3yr term index measures the performance of short-term government bonds issued by the US Treasury.
Bloomberg Barclays US Treasury 20+ Yr TR USD: The Index is market capitalization weighted and includes all of the securities that meet the Index criteria. The index includes all publicly issued, U.S. Treasury securities that have a remaining maturity greater than 20 years, are non-convertible, are denominated in U.S. dollars, are rated investment grade (Baa3 or better) by Moody’s Investors Service, are fixed rate, and have more than $150 million par outstanding. Excluded from the Index are certain special issues, such as flower bonds, targeted investor notes (TINs) and state and local government series bonds (SLGs), and coupon issues that have been stripped from assets already included.
Bloomberg Barclays US Treasury TR USD: The U.S. Treasury Index includes public obligations of the U.S. Treasury. Treasury bills are excluded by the maturity constraint but are part of a separate Short Treasury Index. In addition, certain special issues, such as state and local government series bonds (SLGs), as well as U.S. Treasury TIPS, are excluded. STRIPS are excluded from the index because their inclusion would result in double-counting. Securities in the index roll up to the U.S. Aggregate, U.S. Universal, and Global Aggregate Indices. The U.S. Treasury Index was launched on January 1, 1973.
Bloomberg Barclays US Treasury US TIPS TR USD: The Index includes all publicly issued, U.SS Treasury inflation-protected securities that have at least 1 year remaining to maturity, are rated investment grade and have $250 million or more of outstanding face value. In addition, the securities must be denominated in U.S. dollars and must be fixed rate and nonconvertible. The Index is market capitalization weighted and the securities in the Index are updated on the last calendar day of each month.
Europe Stoxx 600: The STOXX Europe 600 Index is derived from the STOXX Europe Total Market Index (TMI) and is a subset of the STOXX Global 1800 Index. With a fixed number of 600 components, the STOXX Europe 600 Index represents large, mid and small capitalization companies across 18 countries of the European region: Austria, Belgium, Czech Republic, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.
Russell 1000 Growth Index (R1000 Growth): Measures the performance of the Russell 1000 companies with higher price-tobook ratios and higher forecasted growth values.
Russell 1000 Index (Russell 1000): Measures the performance of the 1,000 largest companies in the Russell 3000 Index. Frank Russell Co. ranks the US common stocks from largest to smallest market capitalization at each annual reconstitution period. The Russell 1000 Index represents the vast majority of the total market capitalization of the Russell 3000 Index. It is considered to be generally representative of US Equity Large Cap performance.
Russell 1000 Value Index (R1000 Value): Measures the performance of the Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values
Russell 2000 Growth Index (R2000 Growth): Measures the performance of those Russell 2000 companies with higher priceto-book ratios and higher forecasted growth values.
Russell 2000 Index (Russell 2000): Measures the performance of the 2,000 smallest companies in the Russell 3000 Index. Frank Russell Co. ranks the US common stocks from largest to smallest market capitalization at each annual reconstitution period. The Russell 2000 Index represents a very small percentage of the total market capitalization of the Russell 3000 Index. It is considered to be generally representative of US Equity Small and Mid Cap performance.
Russell 2000 Value Index (R2000 Value): Measures the performance of those Russell 2000 companies with lower price-tobook ratios and lower forecasted growth values Russell 3000 Growth: The Russell 3000 Growth Index measures the performance of the broad growth segment of the U.S. equity universe. It includes those Russell 3000 Index companies with higher price-to-book ratios and higher forecasted growth values.
Russell 3000 Index (Russell 3000): Measures the performance of the 3,000 largest US companies based on total market capitalization, which represents nearly the entire market capitalization of the investable US equity market. Frank Russell Co. ranks the US common stocks from largest to smallest market capitalization at each annual reconstitution period. Russell 3000 Value: The Russell 3000 Value Index measures the performance of the broad value segment of U.S. equity value universe. It includes those Russell 3000 Index companies with lower price-to-book ratios and lower forecasted growth values.
Russell Midcap Growth Index (Russell Midcap Growth): Contains those Russell Midcap (800) securities with a greater thanaverage growth orientation. Companies in this index tend to exhibit higher price-to-book and price-earnings ratios, lower dividend yields and higher forecasted growth values than the Value universe.
Russell Midcap Index (Russell Midcap): Measures the performance of the mid-cap segment of the US equity universe. The Russell Midcap Index includes the smallest 800 securities in the Russell 1000.
Russell Midcap Value Index (Russell Midcap Value): Contains those Russell Midcap (800) securities with a less-than average growth orientation. Securities in this index generally have lower price-to-book and price-earnings ratios, higher dividend yields and lower forecasted growth values than the Growth universe. S&P 500 Index: The S&P 500 Index consists of 500 stocks chosen for market size, liquidity, and industry group representation. It is a market value weighted Index (stock price times number of shares outstanding), with each stock’s weight in the Index proportionate to its market value. The Index is one of the most widely used benchmarks of US Equity Large Cap performance.
S&P 500 Sector/Consumer Discretionary Index: The S&P 500 Sector/Consumer Discretionary Index consists of stocks chosen for their representation in the Consumer Discretionary industry. The companies in the index tend to be the most sensitive to economic cycles. Manufacturing companies include automotive, household durable goods, textiles and apparel, and leisure equipment. Service companies include hotels, restaurants/leisure facilities, media production and services, consumer retailing and services and education services. It is a market value weighted Index (stock price times number of shares outstanding), with each stock’s weight in the Index proportionate to its market value. S&P 500 Sector/Consumer Staples Index: The S&P 500 Sector/Consumer Staples Index consists of stocks chosen for their representation in the Consumer Staples industry. The companies in the index tend to be the less sensitive to economic cycles. They include manufacturers and distributors of food, beverages and tobacco, and producers of non-durable household goods and personal products; also food and drug retailing companies. It is a market value weighted Index (stock price times number of shares outstanding), with each stock’s weight in the Index proportionate to its market value.
S&P 500 Sector/Energy Index: The S&P 500 Sector/Energy Index consists of stocks chosen for their representation in the Energy industry. The companies in the index are dominated by either the construction for provision of oil rigs, drilling equipment and other energy-related service and equipment or the exploration, production, marketing, refining and/or transportation of oil and gas products, coal and consumable fuels. It is a market value weighted Index (stock price times number of shares outstanding), with each stock’s weight in the Index proportionate to its market value.
S&P 500 Sector/Financials TR Index: The S&P 500 Sector/Financials Index consists of stocks chosen for their representation in the Financials industry. The companies in the index are involved in activities such as banking, consumer finance, investment banking and brokerage, asset management, insurance and investments, and real estate, including REITs. It is a market value weighted Index (stock price times number of shares outstanding), with each stock’s weight in the Index proportionate to its market value.
S&P 500 Sector/Healthcare TR Index: The S&P 500 Sector/Healthcare Index consists of stocks chosen for their representation in the Healthcare industry. The companies in the index are involved in health care equipment and supplies, health care-related services, or in the research, development, production and marketing of pharmaceuticals and biotechnology products. It is a market value weighted Index (stock price times number of shares outstanding), with each stock’s weight in the Index proportionate to its market value.
S&P 500 Sector/Industrials TR Index: The S&P 500 Sector/Industrials Index consists of stocks chosen for their representation in the Industrials industry. Companies include those that manufacture and distribute capital goods (i.e. aerospace/defense, construction, engineering and building products, electrical equipment and industrial machinery); provide commercial services and supplies (i.e. printing, employment, environmental/office services); or provide transportation services (i.e. airlines, couriers, marine, road/rail and transportation infrastructure). It is a market value weighted Index (stock price times number of shares outstanding), with each stock’s weight in the Index proportionate to its market value.
S&P 500 Sector/Information Technology TR Index: The S&P 500 Sector/Information Technology Index consists of stocks chosen for their representation in the Info Tech industry. Companies considered are involved in technology software and services and technology hardware and equipment. It is a market value weighted Index (stock price times number of shares outstanding), with each stock’s weight in the Index proportionate to its market value.
S&P 500 Sector/Materials TR Index: The S&P 500 Sector/Materials Index consists of stocks chosen for their representation in the Materials industry. These include companies that manufacture chemicals, construction materials, glass, paper, forest products and related packaging products, metals, minerals and mining companies, including steel producers. It is a market value weighted Index (stock price times number of shares outstanding), with each stock’s weight in the Index proportionate to its market value.
S&P 500 Sector/Telecommunication Services TR Index: The S&P 500 Sector/Telecom Services Index consists of stocks chosen for their representation in the Telecom industry. The companies in the index are involved in health care equipment and supplies, health care-related services, or in the research, development, production and marketing of pharmaceuticals and biotechnology products. It is a market value weighted Index (stock price times number of shares outstanding), with each stock’s weight in the Index proportionate to its market value.
S&P 500 Sector/Utilities TR Index: The S&P 500 Sector/Utilities Index consists of stocks chosen for their representation in the Utilities industry. Companies considered include electric, gas or water utilities, or companies that operate as independent producers and/or distributors of power. It is a market value weighted Index (stock price times number of shares outstanding), with each stock’s weight in the Index proportionate to its market value.
S&P/LSTA Leveraged Loan TR: The S&P/LSTA U.S. Leveraged Loan 100 Index is designed to reflect the performance of the largest facilities in the leveraged loan market. Yield Index but caps issuer exposure at 2%. Index constituents are capitalization-weighted, based on their current amount outstanding, provided the total allocation to an individual issuer does not exceed 2%. Issuers that exceed the limit are reduced to 2% and the face value of each of their bonds is adjusted on a pro-rata basis. Similarly, the face values of bonds of all other issuers that fall below the 2% cap are increased on a pro-rata basis. In the event there are fewer than 50 issuers in the Index, each is equally weighted and the face values of their respective bonds are increased or decreased on a pro rata basis.
The success of an investment program may be affected by general economic and market conditions, such as interest rates, availability of credit, inflation rates, economic uncertainty, changes in laws and national and international political circumstances. These factors may affect the level and volatility of securities prices and the liquidity of a portfolio’s investments. Unexpected volatility or illiquidity could result in losses.
Investing in securities is speculative and entails risk. There can be no assurance that one’s investment objectives will be achieved or that an investment strategy will be successful. Significant losses could result if a strategy involves the use leverage, short sales and derivative transactions, investment in foreign or illiquid securities, and potentially limited diversification. Past performance is not a guarantee of future results.
For fixed income securities, there is a risk that the price of these securities will go down as interest rates rise. Another risk of fixed income securities is credit risk, which is the risk that an issuer of a bond will not be able to make principal and interest payments on time. Liquidity risk is the risk that you might not be able to buy or sell investments quickly for a price that is close to the true underlying value of the asset. When a bond is said to be liquid, there's generally an active market of investors buying and selling that type of bond. High yield fixed income securities are considered to be speculative and involve a substantial risk of default. Adverse changes in economic conditions or developments regarding the issuer are more likely to cause price volatility for issuers of high yield debt than would be the case for issuers of higher grade debt securities.
Special Risks of Foreign Securities
Investments in foreign securities are affected by risk factors generally not thought to be present in the US. The factors include, but are not limited to, the following: less public information about issuers of foreign securities and less governmental regulation and supervision over the issuance and trading of securities.
Special Risks of Small Market Capitalization Securities
Investments in companies with smaller market capitalization are generally riskier than investments in larger, well-established companies. Smaller companies often are more recently formed than larger companies and may have limited product lines, distribution channels and financial and managerial resources. These companies may not be well known to the investing public, may not have significant institutional ownership and may have cyclical, static or moderate growth prospects. There is often less publicly available information about these companies than there is for larger, more established issuers, making it more difficult for the Investment Manager to analyze that value of the company. The equity securities of small and mid-capitalization companies are often traded over-the-counter or on regional exchanges and may not be traded in the volume typical for securities that are traded on a national securities exchange. Consequently, the Investment Manager may be required to sell these securities over a longer period of time (and potentially at less favorable prices) than would be the case for securities of larger companies. In addition, the prices of the securities of small and midcapitalization companies may be more volatile that those of larger companies.
Special Risks of Master Limited Partnerships
Master limited partnerships (MLPs) are publicly listed securities that trade much like a stock, but they are taxed as partnerships. MLPS are typically concentrated investments in assets such as oil, timber, gold and real estate. The risks of MLPS include concentration risk, illiquidity, exposure to potential volatility, tax reporting complexity, fiscal policy and market risk. MLPS are not suitable for all investors.
© 2020 All rights reserved. This report is intended for informational purposes only. All information provided and opinions expressed are subject to change without notice. The information and statistical data contained herein have been obtained from sources we believe to be reliable. No part of this report may be reproduced in any manner without the written permission of Oppenheimer Asset Management or any of its affiliates. Any securities discussed should not be construed as a recommendation to buy or sell and there is no guarantee that these securities will be held for a client’s account nor should it be assumed that they were or will be profitable. The Consulting Group is a division of Oppenheimer Asset Management. Oppenheimer Asset Management is the name under which Oppenheimer Asset Management Inc. (“OAM”) does business. OAM is an indirect, wholly owned subsidiary of Oppenheimer Holdings Inc., which is also the indirect parent of Oppenheimer & Co. Inc. (“Oppenheimer”). Oppenheimer is a registered investment adviser and broker dealer. Securities are offered through Oppenheimer. 5507406.1