The equity market churned sideways for most of April before strong earnings on the last two trading days pushed the S&P 500 higher by +1.6% for the month. The S&P 500 has increased by +9.2% this year and is also about +17.6% above the 2022 closing low on October 12, 2022. Despite the strong performance over the last six months, the S&P is still in bear market territory (a decline of -20% on a closing basis without a subsequent +20% increase) and now sits about -11.2% below the all-time high reached on January 3, 2022.

Market Cap: Large Caps (+1.6%) outperformed Mid (-0.8%) and Small (-1.8%).
Style: Value (Russell 1000 Value: +1.5%) exceeded Growth (Russell 1000 Growth: +1.0%).
Sector: Eight of eleven sectors were positive in the month with Communication Services (+3.8%) and Consumer Staples (+3.6%) as the top performers and Consumer Discretionary (-1.0%) and Industrials (-1.2%) as the laggards.

Nothing that occurred in April has altered either our short- or long-term market outlooks. In the short-term (months), our view is that volatility will remain for a while longer. The S&P 500, currently at 4,169, has been stuck in a trading range from 3,600 to 4,300 for nearly 12 months. During that period, evidence of disinflation pushed the market toward the top end of the range, while signs of elevated inflation pushed the index toward the bottom. While inflation is still the key to the markets in the short-term as it will likely determine the Fed’s next move and the future state of the economy, investors must now also consider potential contagion in the banking industry along with the upcoming debt ceiling debate as significant risks. We expect the S&P 500 to remain rangebound for the time being as the fundamentals of the stock market do not support a rapid recovery back to all-time highs yet. Importantly, for actively managed portfolios, a rangebound market does not mean that we are planning to sit on our hands. If the market were to break below this range to a new cycle low, our short-term view would turn more positive and we would look to add to equities in some instances. If the S&P were to break above the range and toward all-time highs, our short-term view would turn increasingly cautious, and we would begin trimming equities in some instances. Please remember that the economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Over the long-term (years), we still suspect this difficult economic environment has created a strong opportunity for investors willing to live with some short-term discomfort. The attached chart, Investing After Market Declines, utilizes S&P 500 month-end data from 1940 – 2021 and shows that investing when the index is down more than -10% from the all-time high has produced both strong average annualized returns and a high percentage of positive outcomes. We believe those who were able to either stay invested, rebalance, or add to their existing holdings will eventually be rewarded. Historically, equity markets have recovered from recessions and downturns; however, past performance is no guarantee of future returns. It is important to consider your own risk tolerance, financial circumstances, and time horizon.

We continue to rely on our time-tested process while looking for opportunities to tax loss harvest, reposition and rebalance portfolios, and selectively put money to work for clients that have recently made contributions to their accounts. On the equity side, we remain tilted toward high quality US stocks. On the fixed income side, we are taking advantage of the highest yields in over a decade while continuing to focus on pursuing ballast, stability, and income as well as accounting for short-term cash needs.

The markets have several major events over the next month, including, JOLTS Job Openings Report (5/2), FOMC Meeting (5/3), April Employment Report (5/5), CPI Inflation (5/10), and PCE Inflation (5/26).

At Winthrop Wealth, we follow a Total Net Worth Approach and we believe the right mindset paired with a comprehensive financial plan and a thorough investment process can provide confidence in pursuing your long-term financial goals, especially during times of heightened market volatility. We help our clients navigate challenging markets by seeking to ensure their short-term cash flow needs are met while managing the rest of their investments in a globally diversified portfolio. By having two to three years of scheduled cash flows invested in ultra-short fixed income instruments, we seek to decrease the likelihood that we will need to sell out of risk assets after a market decline to fund distributions. Please remember that no strategy assures success or protects against loss.

● Framework for Navigating Current Conditions
● Market Timing Does Not Work
● Bond Primer
● The Debt Ceiling
● Silicon Valley Bank Failure
● Tax-Loss Harvesting

Fixed Income Market

The Bloomberg Barclays US Aggregate Bond index (Agg), which acts as a proxy for the investment-grade bond market, increased by +0.6% in April as the 10-Year Treasury yield declined from 3.47% to 3.42% during the month (bond prices move inversely to interest rates and credit spreads). The bond market is still trying to find its footing after coming off the worst calendar year (2022: -13%) since inception of the index in 1976. Please see our Client Question: Bond Primer where we detail bond mechanics, characteristics, types, risks, and historical returns.

Our objective with fixed income is to provide ballast, stability, and income to portfolios. Ballast means that, ideally, the fixed income holdings are increasing when equity markets are declining. Bonds did not provide ballast for most of 2022 as interest rates rapidly increased during the first half of the year. We have continuously stated that we expect the negative correlation between stocks and bonds to return in the future once yields level out and that all else equal the fixed income markets need yields to stabilize rather than decrease to achieve positive returns. We will highlight the following time periods and note that the Bond market has produced solid returns over the last ten months:

Source: Bloomberg

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.

The Treasury yield curve is still inverted with both the 3-Month (5.03%) and 2-Year (4.01%) higher than the 10-Year (3.42%) yield. In general, the Fed controls shorter term Treasury yields by setting the target federal funds rate while the market controls long term rates as investor demand will vary based on future expectations of inflation and economic growth. An inverted yield curve is a sign of a pessimistic economic outlook and typically signals that investors expect the Fed to cut rates soon. If the Fed does cut rates as investors expect, the 3-Month and 2-Year yields will fall below the 10-Year and the yield curve will be upward sloping again. Please see our Client Question: Yield Curve Inversion.

The yield to maturity of various bond indices remain at their highest levels in years. Yield to maturity is defined as the estimated annualized rate of return an investor can expect on a bond if purchased today and held to maturity, assuming the issuer makes all their interest and principal payments (i.e., no defaults). The yield to maturity on the US Aggregate Bond index was 4.4% at the end of the month, which is the highest level since 2009. In other words, future returns from the Agg bond index have not been this attractive in 14 years.

Monetary Policy

The next Fed meeting will occur on May 3rd where the committee is expected to raise interest rates by another 25 basis points (0.25%) to bring the top end of the federal funds rate to 5.25%. At their last meeting, the Fed indicated that the upcoming rate increase would likely be the final one for this period. If May is indeed the last rate hike, it would cap one of the quickest monetary policy tightening cycles in United States history. Since March of 2022, the top end of the federal funds rate will have increased from 0.25% to 5.25%.

If the Fed does indeed signal a pause, the logical questions will be around the timing and direction of their next move. With inflation at present levels, many Fed officials would prefer further rate increases, while turmoil in the banking system would historically necessitate rate cuts. Putting it all together, the Fed will likely wait and see how inflation and the economy evolve over the next several months. If inflation breaks higher, more rate hikes are on the table. On the other hand, if inflation continues to decelerate or the economy rapidly deteriorates, the Fed will begin to lower interest rates. The bond market is already anticipating rate cuts soon as evidenced by the 2-Year Treasury yield falling from 5.07% on March 8th to 4.01% at the end of the month.

Please see our Client Question on The Fed which details the key entities, and the impact monetary policy has on the economy, interest rates, and stock prices.

Inflation

While most readings have decelerated over the past few months and are below peak levels, current inflation data is still elevated. The Fed has divided inflation into three buckets: goods (decelerating as supply chains normalize), housing (decelerating under rising mortgage rates but not showing up in inflation data until mid-2023), and non-housing related core services (still elevated due to the strong labor market and robust average hourly earnings).

The Fed’s latest Summary of Economic Projections show the median participant expects Core PCE Inflation to fall to 3.6% in 2023, 2.6% in 2024, and 2.1% in 2025.

Consumer Price Index (CPI): tracks the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. The index does include food and energy prices.
● Latest Reading (March): 5.0%.             Prior Reading (February): 6.0%.
● Peak (June 2022): 9.1%.                        Source: Bureau of Labor Statistics.

Core Personal Consumption Expenditure (PCE) Index: measures the prices paid by consumers for goods and services based on surveys of what businesses are selling. Core means that the index excludes food and energy prices. This is the Fed’s preferred inflation measure, which they target at an average of 2%.
● Latest Reading (March): 4.6%.                  Prior Reading (December): 4.7%.
● Peak (February 2022): 5.4%.                     Source: Bureau of Economic Analysis.

Average Hourly Earnings: tracks total hourly renumeration (in cash or in kind) paid to employees in return for work done (or paid leave). Data is from the Current Employment Statistics (CES) survey.
● Latest Reading (March): 4.2%.                             Prior Reading (February): 4.6%.
● Peak (April 2020): 8.0%.                                        Source: Bureau of Labor Statistics.

US Economy

The US economy continues to meander along as first quarter GDP came in at a mild +1.1% seasonally adjusted annual rate. The underlying report showed consumption (70% of GDP) as a bright spot at +3.7% while inflation continues to be a drag. Current estimates are that Q1 GDP will be the high watermark for the year (Q2: +0.3%, Q3: -0.6%, Q4: -0.3%). The economy has not yet entered an official recession, but the consensus view is that a recession will occur soon.

We started writing that a mild US recession felt inevitable last summer, and our view has not changed as several recessionary indicators are still flashing yellow or red, including the yield curve, leading economic indicators, and the ISM Manufacturing survey. Meanwhile, the strength of the economy currently lies with the labor market as the unemployment rate of 3.6% is close to a 50-year low. With the Fed actively trying to soften the labor market to bring down inflation by lowering the overall demand for goods and services, we expect the unemployment rate to tick up over the next few months.

An over-simplified business cycle historically followed a similar pattern: the economy expands rapidly – unemployment falls – inflation overheats – financial bubbles form – the Fed responds by raising interest rates – credit tightens – good borrowers struggle to find loans – the economy stumbles – a recession occurs – the economy bottoms – repeat. We’ve seen the first stages of the business cycle play out starting in mid-2020. The turmoil in the banking sector that started with Silicon Valley Bank may end up tightening credit enough to push the economy into a recession. According to the latest FOMC minutes, the Fed now projects “a mild recession starting later this year given the assessment of the potential economic effects of the recent banking-sector developments.”

The good news for long-term investors is that the S&P 500 already priced in an average recession last year when the index fell by -24.5% from January 3rd through October 12th. We are not sure if October 12th marks the ultimate bottom for this period, although unless your view is that this is the start of another Great Depression or Financial Crisis, then a lot of the damage in the equity market may have already occurred at the October low.

A key tenant to our investment philosophy is to maintain a long-term viewpoint. A lot of short-term predictions about the market or the economy are just noise. As such, we focus on the fact that recessions can create buying opportunities for long-term investors. During the last 15 recessions, the S&P 500 declined by an average of -30.0%. However, once the market bottomed, performance was very strong over subsequent 1-YR (+50.1%), 3-YR (+79.0%), and 5-YR (+142.1%) periods. Historically, equity markets have recovered from recessions and downturns; however, past performance is no guarantee of future returns. It is important to consider your own risk tolerance, financial circumstances, and time horizon.

April 2023 Returns

Source: Bloomberg