First Quarter Commentary: Resiliency Through Federal Rate Increases

The U.S. economy proved to be resilient through much of the first quarter of 2023.  From March 2022 through March 2023, the Fed increased rates by a multiple of 19 from a range of 0.0%-0.25% to the range of 4.5%-4.75%. Despite the rate increases, jobs steadily grew, consumers and businesses continued to spend, the economy sustained growth at a reasonable pace, and inflation declined. However, there were underlying problems that remained hidden, until this past March. The rate increases caused problems for banks who had constructed balance sheets and loan books around an ultra-low interest rate environment. When rates increased, the model broke, and three banks defaulted in early March.

At first glance, the economic data for March suggests the economy will be resilient despite the banking issues. For example, the economy grew jobs in March and the services sector continued to expand. However, a more in-depth study of economic data shows we should be wary of a more pronounced economic slowdown. The service sector of the economy expanded in March, but the level of activity fell just short of solidly expanding in February. The manufacturing sector fell further into contraction, indicating the economy is just above stall speed. In addition to economic slowdown concerns is the banking data of the past two weeks. The Fed produces a weekly report on the balance sheet of banks in the U.S., and the two most recent weekly reports show loans contracting by $105 billion. We are now seeing contraction in the credit markets, and since credit is the life blood of the economy, the tightening financial conditions could slow the economy to below stall speed.

What does this mean for client portfolios? We believe we have built portfolios to weather an economic slowdown better than the markets overall. We build portfolios to perform well when markets are negative and in normal up markets. The performance of Allen Trust Company in the down markets of 2022 illustrate this point; our clients’ portfolios outperformed in both stocks and bonds. In the first quarter, stocks rose a strong 7.5% in the quarter and bonds increased just under 3%, resulting in a blended return of about 5.3%; client portfolios were up approximately 4.7%, net of fees. Focusing on preserving capital remains a core tenant of how we manage money. This method ensures that clients will be in a better position as we emerge from the slowdown by reducing the percentage return needed to reach the level just prior to the downturn.