Stocks posted solid gains in the first quarter as investors navigated corporate earnings, shifting monetary policy, and troubles in the banking sector.
The first quarter of 2023 saw the Dow Jones Industrial Average rise 0.38%, the Standard & Poor’s 500 Index gained 7.50%, and the Nasdaq Composite picked up 16.77%.
A January Rally
Stocks rallied in January, driven by cooling inflation, a better-than-expected start to earnings season, and healthy economic data. Where investor sentiment had been weighed down by concerns over interest rates, a new, more upbeat mood surfaced.
Stocks Stumble in February
However, strong economic data released over the course of February diminished investor hopes of a pause in rate hikes, which dragged stocks lower.
Fourth quarter earnings were a bit underwhelming, though they generally met the market’s low expectations. While 68% of the companies comprising the S&P 500 exceeded Wall Street’s earnings estimates, this was below the five-year average of 77%. Moreover, despite the number of positive earnings surprises, earnings declined for the first time since 3Q 2020, falling by 4.9%.
March Twists & Turns
Stocks entered March holding onto modest year-to-date gains, but the final month of the first quarter would prove to be its most dramatic.
Interest rate fears flared up once again, ignited by congressional testimony by Fed Chair Powell, who suggested that rates may need to be hiked higher and faster than the Fed had anticipated.
Selling pressure accelerated after regulators took over two U.S. banks. Fears rose that the banking sector issues were widening after a Swiss bank was taken over by a competitor.
The difficulties within the banking system also changed market sentiment regarding future rate hikes. While the Fed raised rates 25 basis points in March, Fed Chair Powell hinted that the end of the rate-hike cycle was nearing.
Stocks steadied as banking fears eased, notching gains at the close of the month and leaving stocks higher for the quarter.
Quarterly Sector Scorecard
For the quarter, big gains were posted in Communications Services (+20.80%), Consumer Discretionary (+15.78%), and Technology (+21.35%), while Industrials (+3.02%), Materials (+3.84%), Real Estate (+1.22%), and Consumer Staples (+0.21%) saw modest increases. Energy (-5.30%), Financials (-5.99%), Health Care (-4.70%), and Utilities (-3.99%) all experienced losses.
Investor optimism grew overseas as well, as Europe emerged from winter in far better shape than feared, and China continued its reopening progress.
For the quarter, the MSCI-EAFE (Developed International) Index jumped 8.47%. In addition, Developed International markets outperformed the U.S. for 2022 and thus far in 2023.
The Fed implemented two rate hikes of 0.25%, one each in February and March, in its year-long effort to combat inflation.
The March increase came after regulators took control of two regional banks, which raised some fears about the banking sector.
The official announcement accompanying March’s rate hike decision hinted that the Fed may be done raising rates soon. The statement also reiterated the Fed’s belief in the banking system’s soundness, while acknowledging that it was too early to determine how banking issues may impact the economy.
Fed Chair Powell, in his post-meeting press conference, said that consideration had been given to stop hiking rates, but that the Federal Open Market Committee believed that elevated inflation and solid economic activity were reasons to raise rates despite concerns about the banking sector.
What Investors May Be Talking About in April
Companies have started reporting first quarter earnings, but actual financial results may be of only secondary importance.
The market’s earnings expectations are quite low as Wall Street analysts’ earnings estimates have come down by 5.7% between the end of December and February. While first quarter estimates tend to be lowered, the average cut in earnings estimates over the past five years was a much more modest 2.3%.
Markets may be more interested to hear what corporate leaders have to say about the future, particularly in light of an uncertain economic landscape created by recent banking issues.
One potential concern is whether a tighter lending environment will emerge as banks look to manage risk. Fed Chair Powell referred to this possibility in his post-Federal Open Market Committee meeting press conference when he suggested that financial conditions may have tightened more than traditional signs are reflecting.
Over the last three quarters, the number of S&P 500 companies citing “recession” on their earnings calls fell from 241 to 148. Investors may look to see whether these diminishing concerns over recession reverse in the weeks ahead.