Q1 2023 Market Commentary “Fixing the Cracks”

Apr 11, 2023 | Market Updates

Cosmetic or Structural?

Like many of you, I have lived in multiple houses. One of these houses was old. So old in fact, that on the county property assessor’s website, the property was listed as “Built in: Old” (as public records in the area only went back to 1900). We loved our quaint, semi updated pre-1900 home yet with each passing year, as houses do, our charismatic domicile was in constant need of repair. Each repair seemingly took double the amount of time that would normally be required or, worse, would open up a whole new project. For example, replacing flooring gets more difficult when the floor is uneven. In other words, simple cosmetic repairs turned into structural projects that often required architects, engineers, and specialized tools. Being able to distinguish between cosmetic and structural repairs will often save time, money, and emotional stress. These challenges with my old house remind me of the situation we are currently in with the economy. 

When looking at the current state of the economy, it seems like for every two steps forward, we take one step back. The inflation we have experienced since the end of the COVID-19 pandemic has caused some cracks in our economy such as the demise of Silicon Valley Bank and Signature Bank, the FTX crypto currency bankruptcy, and the fire sale of Credit Suisse. At this point in time, we believe these are cosmetic cracks that can be easily patched and not cracks that could lead to structural issues in the stability of our economy’s foundation. Let’s review the current status of inflation in the United States, the severity of the cracks we are seeing in the banking system, and the overall health of the U.S. economy.  

Inflation

Inflation is a stressor that can cause structural issues in an economic foundation. It is a big enough concern that we have hired a full-time “contractor,” the Federal Reserve, to be on staff monitoring where inflation is and where it is going. In March of 2022, the Federal Reserve started a construction project to contain inflation, and like many contractors, extended the project completion date several times to where the Federal Reserve’s fix (restrictive monetary policy and relatively high interest rates) is lasting longer than expected. Through the dust of the construction site, we see noticeable progress as inflation continues to trend lower. 

The Banking System 

At the beginning of 2023, we anticipated that the middle of the year would be volatile due to the continued stress the Federal Reserve was putting on the economy through higher interest rates. The expectation was that the Federal Reserve would be comfortable with the formation of new cosmetic cracks in the U.S. economy as long as the cracks did not lead to any structural issues. If it reached the point of causing structural issues, the Federal Reserve would have reached the end of its rate hiking cycle, with interest rates stabilizing and slowly decreasing over time. This would provide relief to embattled stocks. 

The banking system made headlines this past quarter with the high-profile failures of Silicon Valley Bank and Signature Bank, along with the emergency fire sale of Credit Suisse. Business failures are a normal part of the economic cycle and is evident in late cycle expansions and recessions. Because of current regulations and risk management processes, the Federal Reserve, the U.S. Treasury, and the FDIC were able to reduce any contagion by guaranteeing the funds of all depositors while creating a credit lending facility to provide additional liquidity to banks through the Federal Reserve.  

At GreenUp Wealth Management we do not believe these banking cracks will widen into a financial crisis like we saw in the Great Recession of 2007-2009. We do expect extra stress on the banking system, especially in regional banks, to matriculate through the financial sector and lead to the beginning of a credit crunch, where credit is readily available but with much higher lending standards. We anticipate additional bank failures in the United States, with the FDIC moving in swiftly as it did with the Silicon Valley Bank failure, ensuring bank customers do not lose money and to containing potential systemic risk. At this point we are not concerned about a systemic failure of the banking system. The Federal Reserve will likely slow or pause interest rate hikes to keep cracks from expanding into something worse. 

The Overall Economy 

Over the past year-and-a-half, we have seen many cracks in various industries. However, these cracks are repairable, and at least for now, there does not appear to be anything wrong with the foundation of the economy. We should expect to have cracks in a slowing economic environment. What is interesting and somewhat unique about the current situation is that we do not see pressure on all assets classes or sectors at the same time, which reinforces the projection for a soft landing or mild recession. High growth, technology, cryptocurrency, real estate, and most recently banking are sectors that have rolled into and out of contraction over the last 12 months. All the while, other industries are making money and growing. While the economy may need a temporary excess supply of spackle, sandpaper, and paint through 2023, eventually the walls will be patched and we anticipate a return to growth, most likely in 2024.  

The broader economy has shown resilience in the face of challenges, with above-average consumer spending and continued low unemployment. With wages increasing at a rate of 5.3% per year (keeping pace with inflation) and 10.8 million job openings in the month of January, the U.S. consumer remains strong and, thus, so does the economy, for now. 

Home Improvement for a Brighter Financial Future 

Inflation and other challenges have created a need for improvements in the U.S. economy. As with many home improvement projects, progress has been slow and frustrating, yet we see actual progress as the S&P 500 finished the quarter up 14.9% from its lows on Oct 12, 2022. With the most recent 0.25% rate hike by the Fed, we are nearing a terminal rate which is when the Federal Reserve stops hiking interest rates. This will lead to a more consistent business environment, as the market balances the current reality of restrictive rates with an expectation of lower interest rates in the future. In time we expect lower volatility to lead to future growth. 

While current price-to-earnings valuations remain elevated in the U.S. equity market, we expect more attractive valuations when we return to a period of higher earnings growth. At GreenUp, we acknowledge the lower valuations of international equities, but are mindful of foreign markets risk, especially in Europe where countries are reconciling challenging economic realities as workers in France, Germany, and England are staging large strikes. 

After a steep rise in interest rates, bond markets are beginning to normalize, allowing fixed income investors to finally be rewarded with more attractive yields. When the Federal Reserve achieves a terminal funds rate, interest rate risk in longer term bonds will decrease substantially, lowering risk to principal. 

Our GreenUp allocation portfolios remain well-diversified as we wait for an economic recovery. We are adding longer-term treasury bonds and increasing our allocation to Emerging Market equities as China’s economy returns from COVID lockdowns. 

Investors may need to have patience as we move towards a new economic expansion, likely by the end of 2023 and into 2024. Inflation and high interest rates will continue to cause cracks that will require patching to prevent future damage to the economy, ultimately restoring stability and readying our economic house for the next expansion.

GreenUp Portfolio Updates

Active Allocation Models (Dynamic, Index, ESG) 

We are maintaining 110% portfolio risk relative to the benchmarks. When compared to their benchmarks, our allocation portfolios continue underweights in Large Cap Growth, Large Cap Core, Mid Cap Core, and Mid Cap Value. Even though we are underweighting mid-cap equities, we increased mid-cap holdings compared to last quarter as the asset class is considered inexpensive by valuation standards. 

We are overweighting Large Cap Value, Small Cap Value, Small Cap Core, International Developed Markets, and International Emerging Markets based on above average expected earnings growth compared to the benchmarks.  
 
We added iShares Russell Mid-Cap Growth (IWP) and sold US Global Jets ETF (JETS). 

Large Cap Stock Model 

We sold Adobe (ADBE), Analog Devices, Inc.(ADI), CVS Health Corp (CVS), Fiserv Inc (FISV), Iqvia Holdings Inc (IQV), Lam Research Corporation (LRCX), Sanofi SA (SNY), and Taiwan Semiconductor (TSM). 

We bought Air Products & Chemicals, Inc. (APD), Bristol-Myers Squibb Co (BMY), Danaher Corporation (DHR), General Dynamics Corporation (GD), Novartis AG (NVS), and Philip Morris International Inc. (PM). 

Tactical Equity Model 

The quarterly trend remains negative since March 4, 2022. The model is in cash with periodic trades in and out of the market. 


The performance of market indexes is discussed as indexes are generally well recognized as indicators or representations of the stock market or certain sectors. Market index performance does not normally reflect reinvestment of dividends or expenses, and you cannot typically invest in a market index. GreenUp Wealth Management may discuss and display, charts, graphs, formulas, and stock picks which are not intended to be used by themselves to determine which securities to buy or sell, or when to buy or sell them. Such charts and graphs offer limited information and should not be used on their own to make investment decisions. Consultation with a licensed financial professional is strongly suggested. 

The opinions expressed herein are those of the firm and are subject to change without notice. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. 

GreenUp Wealth Management is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.

Author

  • Daniel Greulich, CFA, CFP®

    Chief Investment Officer | Wealth Advisor | Ann Arbor, MI -- Daniel leads our Investment Committee and partners with Aaron Kirsch, Chief Client Advocacy Officer to design and implement client portfolios with your advisor. Daniel brings 14 years of practical experience as a trader, financial advisor, and money manager at both large and mid-sized financial services companies to GreenUp Wealth Management. In addition, he holds a CFP® designation and is also a CFA charterholder. This combination of experience and knowledge helps Dan confidently guide his clients through the development, execution and monitoring of their customized financial plans.

    https://greenupwealth.com/meet-your-team/dan-greulich/ daniel.greulich@greenupwealth.com Greulich, CFA, CFP® Daniel

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