Resilient Economy, Cautious Outlook
While the labor market continues to remain solid, the impact of tighter credit conditions may result in slower economic growth.
The anticipation of a slowing economy and a less aggressive Federal Reserve has led markets into positive territory this year. Volatility may continue, but long-term investors will benefit.
RECESSION STILL NOT EVIDENT
The long-awaited recession was still not evident during the first quarter. As long as people continue to remain employed and see increases in income, the economy will likely not slow as quickly as anticipated by the markets. Large mega companies have announced substantial cutbacks in staffing, but keep in mind they were the companies that increased employment significantly during the pandemic. As the world has normalized, the excessive demand for technology products has subsided. Small- and mid-sized companies that never reached full employment due to lack of workers are not in the position yet where they need to cut staff. In reality, those companies are just reaching a comfortable level of employment. According to the most recent JOLTS report, job openings remain at almost twice the number of unemployed. The pipeline appears to be softening, and the labor supply and demand are coming into better balance. A continued tight labor market may limit the severity or onset of a recession.
BANK FAILURE IMPACT ON THE ECONOMY
The run on bank deposits and the ultimate failure of Silicon Valley Bank (SVB) and Signature Bank of NY (SBNY) caused trauma across the financial system as bank depositors rushed to ensure funds were insured by the FDIC. The failures of these institutions were not a credit event but rather a liquidity issue. While it was not a credit issue, the increased need for funding by small- and mid-sized banks to cover potential outflows may result in less availability for lending. These financial institutions are the heart of small- and mid-sized business lending and if the availability of credit tightens, it may result in less business investment and future economic growth.
FLIGHT TO QUALITY WAS APPARENT
Fear of bank failures and economic recession led to a flight to quality in the investment markets. Investors searched for safety by increasing investments in treasury securities and the largest, most liquid stocks. Markets built in expectations that the Federal Reserve would potentially halt its fight against inflation despite still strong inflationary pressures. Fixed income returns had been in negative territory prior to the SVB collapse but rallied into positive territory before quarter end. The largest tech names with strong cash flow and low debt levels led the stock market higher as the quarter ended as well. Historically, this type of market action provides opportunities for long-term investors. Buckets of investments are often thrown out with the bath water when a crisis occurs. However, many of these investments still have extraordinary value and, in the end, provide a better investment opportunity over the long term.
FEAR OF BANK FAILURES AND ECONOMIC RECESSION LED TO A FLIGHT TO QUALITY IN THE INVESTMENT MARKETS.
HAS INFLATION ROLLED OVER?
Inflation numbers continue to remain at levels above where the Federal Reserve is targeting. There has been some relief from the elevated levels seen in mid-2022, but there are still pockets of inflation. Commodity prices were flat during the quarter after rising during January, declining through mid-March, but rising again heading into quarter end. Oil prices hit a low on March 20 with West Texas Intermediate Crude hitting $64.36 per barrel before rising to $75.67 per barrel as of March 31. Labor costs peaked late last year. A stabilizing market or softening labor market will help ease wage pressures for businesses, which should result in less pressure to raise prices to the end consumer. The Federal Reserve continues to put fighting inflation as its primary objective, although it realizes it may result in a recessionary environment. Slower demand during a recession typically leads to lower inflation.