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A sudden and (mostly) unexpected bank crisis took the S&P 500 on a volatile ride in the month of March, completely shifting the market outlook for interest rates along the way.
The benchmark index was gaining ground in the first days of March until the collapse of Silicon Valley Bank sent global markets into a minor panic. After two weeks of relative market chaos, coordinated efforts by regulators and the big banks to backstop the industry calmed markets.
Fears of a domino effect of failing banks never came true, making investors more optimistic that the worst of the March mini-crisis is over. The stock market should resume its march higher in April, a month that has historically been one of the strongest of the year for the S&P 500.
A Sudden Banking Crisis Rattled Markets
On March 8, popular cryptocurrency bank Silvergate Capital (SI), which held $11 billion in assets, announced it would wind down and liquidate its assets, citing “recent industry and regulatory developments.”
Two days later, the Federal Deposit Insurance Corporation (FDIC) took control of Silicon Valley Bank just days after the company announced a multibillion-dollar loss generated from liquidating its bond holdings to pay depositors. SVB is the largest U.S. bank failure since the collapse of Washington Mutual in 2008.
Then on March 12—a Sunday—the FDIC announced a takeover of crypto bank Signature Bank (SBNY) following a run on the bank’s deposits sparked by the failures of Silvergate Capital and SVB.
The crisis continued on March 16 when U.S. Treasury Secretary Janet Yellen met with JPMorgan Chase CEO Jamie Dimon to organize a coalition of 11 banks to provide a $30 billion liquidity infusion for ailing First Republic Bank (FRC) following a run on its deposits. Even after the emergency rescue, First Republic’s share price remains down nearly 90% year-to-date.
The banking crisis shifted overseas on March 19 as UBS agreed to buy its ailing Swiss rival Credit Suisse for $3 billion in an emergency rescue deal coordinated in part by Swiss regulators. The Swiss government pledged to provide more than $100 billion in liquidity and $9 billion in funds for UBS to backstop losses the bank may incur from Credit Suisse’s assets.
Worries about the crisis spread throughout the banking industry, sending the SPDR S&P Regional Banking ETF (KRE) down 29.4% on the month.
Federal Reserve Chair Jerome Powell reassured investors following the conclusion of the Fed meeting on March 22 that the “banking system is safe” and deposit flows had “stabilized over the last week.”
The Fed Pivot Is Neigh
Looking past the banking crisis, two key market catalysts will remain front and center in April: inflation and interest rates.
The consumer price index gained 6% year-over year in February, down from peak inflation levels of 9.1% in June 2022, but still well above the Federal Reserve’s 2% long-term target.
At the Fed meeting, the Federal Open Markets Committee (FOMC) hiked interest rates by one quarter of a percentage point—a second consecutive smaller raise after the mega hikes of 2022.
Chair Powell calmly noted that “financial conditions seem to have tightened” since the banking crisis began. The Fed released fresh long-term economic projections at the meeting, including an outlook that foresees just one more rate hike before the FOMC pivots on rates and hits pause.
Jeffrey Roach, chief economist at LPL Financial, says the tight financial conditions Powell described have not yet had a material impact on U.S. consumer confidence.
“The availability of jobs and low unemployment more than offset the negative impact from recent banking crises,” Roach says. “That said, recession risks are still elevated as the Fed nears the end of its rate hiking campaign.”
Traders now forecast an approximately 49% chance that the Fed will raise rates by another quarter point at the May 3 meeting—and a 51% chance it could pause on rates, according to CME Group.
Bank of America economist Ethan Harris is still expecting one more rate hike in May—and then no rate cuts until 2024.
“We no longer expect a 25 basis point rate hike in June, and now foresee a terminal rate of 5.00% to 5.25% by May,” Harris says. “We maintain the first rate cut [will be] in March 2024.”
Bank of America projects this path for monetary policy could get U.S. inflation back down to the Fed’s long-term inflation target of 2% by the end of 2024.
U.S. Recession Watch
The Fed is reaching a critical point in its battle against inflation, and the next couple of months will determine whether or not it can navigate a soft landing for the U.S. economy without tipping it into a recession.
In recent months, the U.S. housing market has softened significantly, and manufacturing activity has dropped. In addition, the U.S. Treasury yield curve has been inverted since mid-2022, something that’s historically been seen as a strong recession indicator.
In fact, the New York Fed’s recession model predicts a 54.5% chance of a U.S. recession sometime in the next 12 months.
So far, the most convincing argument a soft landing may still be possible has been the resilience of the U.S. labor market. The Labor Department reported the U.S. economy added 311,000 jobs in February, widely exceeding economists’ expectations. The unemployment rate rose a bit to 3.6%, but that’s still down from 3.8% a year ago.
John Lynch, chief Investment officer at Comerica Wealth Management, is anticipating an economic downturn ahead.
“Solid employment remains a favorable backdrop, in our opinion, suggesting a mild recession,” Lynch says. “Unfortunately, this does not change our view that the October lows for the S&P 500 need to be retested in the coming weeks/months.”
How to Invest in April
The S&P 500 was remarkably resilient in March, especially given the uncertainty radiating from the banking sector and tightening credit markets.
Tech stocks have rallied in recent weeks as expectations for interest rates have fallen. In fact, the Technology Select Sector SPDR Fund (XLK) gained 9% in March, while the VanEck Semiconductor ETF (SMH) gained 9.1%.
Semiconductor market leaders Intel (INTC), Advanced Micro Devices (AMD) and Nvidia (NVDA) each gained more than 17% for the month.
The S&P 500 didn’t drop below its December low in the first quarter of 2023, a market indicator that has historically been a bullish sign for the rest of the year. Since 1950, during years in which the index’s first-quarter low was above its December low, the S&P 500 has averaged a full-year gain of 18.6%.
Value stocks have historically outperformed growth stocks when interest rates are high. High interest rates have a negative impact on discounted cash flow valuations, which can hurt high-growth stocks. In the past year, the Vanguard Value ETF (VTV) has generated a total return loss of 6.9%, while the Vanguard Growth ETF (VUG) has generated a total return loss of 17.2%.
Investors concerned about the potential for a U.S. recession can also take a more defensive approach to the market and increase their financial flexibility in 2023 by dialing back exposure to stocks and increasing their cash holdings.
Chris Zaccarelli, chief investment officer for Independent Advisor Alliance, says a recession appears increasingly inevitable at this point, but investors shouldn’t necessarily be waiting on the sidelines.
“What we are telling our clients is that higher quality companies—those with strong balance sheets that can make it through a recession, are profitable and have sustainable business models—will be rewarded over the full cycle,” Zaccarelli says.