Despite only running one full quarter, 2023 has already been a year of many competing narratives and pricing regimes – almost conveniently placed evenly across each month of the calendar year as it happens.
As Q1 2023 comes to a close and we are left in a potential transition stage to yet another narrative, we thought this was good timing to review what has occurred so far this year and identify which assets benefitted/suffered during different regimes.
January – Soft Landing
The best way to track the narrative regime of the market is to look at the trajectory of the implied Fed Funds Rate (FFR) at the next meeting – in this interest rate-driven environment, this pricing is crucial to see how optimistic or pessimistic investors are.
As January progressed, the market began to price less probability of an aggressive 0.50% increase at the next meeting, seeing it far more likely that the Fed would conduct a more accommodative 0.25% hike and even a marginal possibility of no hike towards the end of the month.
This was an optimistic view, driven by a soft landing narrative, where economic data and investor sentiment after a grim 2022 worked together to paint a picture of a future where the Fed could engineer a decline in inflation without bringing on a severe recession.
The performance of most assets generally reflected this market optimism – global equities rallied over 7%, gold came back to life and rallied nearly the same amount, even Treasuries and Credit saw strength.
Overall, this was a time of market exuberance, with capital being deployed towards risk after capital loss realisation at the end of 2022. And then the market regime flipped to something significantly less optimistic.
February – Hard Landing
The path for implied FFR was almost the mirror opposite of what we saw in January: optimism reigned at the start of the month, with a marginal chance that the Fed may even pause, before a more aggressive outcome got more priced in as the potential reality of a ‘hard landing’ dawned on markets.
The potential for a deep recession to hit the US was a very real thought at the front of the market hivemind in February, spurred by sticky core inflation, mixed economic data giving no clear signal and a disappointing re-opening effort by China.
Anything that rallied in January, reversed in February – gold particularly felt the sting of this U-turn in sentiment, but equities and fixed income were not spared. The movement in US Treasury yields in February set up attractive entry points to buy bonds, particularly as the pricing on credit in the US remained fair-value to expensive – this is a position we executed on recently, as outlined in our previous note.
March – Banking Crisis
Which brings us up to date in what is likely to be one of the heaviest whipsaw market regimes many investors will see within the next few years – pessimism and pricing in the potential for 0.75% rate hikes, to switch to no further hikes within 2023 and the possibility of immediate cuts… all within the span of a few days.
The collapse of Silicon Valley Bank represented the second largest failure of a bank in US history, understandably sending shocks throughout the system. However, it did not have the negative effect on (most) asset prices as you might expect – instead, the narrative shifted to “the Fed’s broken something, now they have to cut!”. Indeed, Fed Chair Powell noted in his March FOMC speech that the regional banking crisis was likely doing their job for them.
The result was that most assets ended up rallying, with the notable exception of regional banks – here using the proxy of the SPDR Regional Bank ETF (KRE:NYSE), which had such poor performance we had to limit the y-axis of the chart.
Swim Against the Tide, or Go with the Flow?
We’ve just concluded a March where, broadly, most indexes of equities and bonds have done remarkably well.
The shifts in narrative throughout this year have been as aggressive as they have been unpredictable – if an investor were to chase any one particular theme, they would have been subsequently chopped up the next month and likely changed their positioning to stem losses.
However, a pragmatic investor who took a longer-term view but was keeping an eye out for opportunities could have found themselves set up well for future performance – US Treasuries was one example, but there were many others amongst the volatility and broad market short-sightedness.
Between the narrative shifts, 2023 has begun with a familiar lesson that having discipline and a structured approach to investing will steer you well when there is risk and panic, and leave you open to take advantage of opportunities when others are being forced to sell.