Our Thoughts on first Quarter 2023
Matt Johnson, CFA® - Andy Nugent, CFA®
Market Recap, Portfolio Analysis, and Review
The S&P 500 began the year with strength despite many hurdles in the economy. Most of the performance was attributable to the Information Technology sector that gained over 21% in the quarter as it fought its way back from a dreadful 2022 in which the sector lost more than 30% of its value. The same themes we have been talking about persisted in the first quarter. The Fed funds rate increased two more times in the quarter as the Fed continued the battle to get inflation down to the 2% target. These rising rates brought higher yields on money market funds and fixed income investments but caused instability for regional banks. The biggest story of the quarter was the failure of Silicon Valley Bank.
Let’s look a bit closer at all of these sub plots that made up the quarter.
The good news is that inflation is way off its highs and is now below 6%. The bad news is that it is nowhere near the 2% the Fed expressed as its goal. Using interest rate increases as its only tool to fight inflation, we wonder if the Fed will pause to see if inflation continues its downward trend without any more nudging.
While the Fed raised rates twice during the first quarter both raises were only 25 basis points giving the market hope that they are close to being finished with hikes. This follows a year in which they raised rates seven times for a total of 4.5%. As we said last quarter, we are hopeful the Fed will pause to give the economy adequate time to digest the higher rates.
As the Fed slowed its role in increasing interest rates, mortgage rates stabilized. In fact, per Bankrate, the average 30-year fixed rate mortgage was little changed from 6.83% to 6.84% at quarter end. Yields on Treasuries are increasing, with short-term treasuries yielding more than longer term treasuries. Six-month treasuries were yielding 4.94% at quarter end, with money market rates climbing as well.
The rising interest rates have made purchasing bonds more attractive. We continue targeting short term maturities from 3 months to a year. We hold them until maturity and roll proceeds into additional treasuries.
As a reminder, to achieve the stated yield for any new issue bond, one must hold it to maturity. If an investor sells a bond before it matures in a rising interest rate environment, they will get a lower price on the sale of said bond which will result in a loss, as Silicon Valley Bank found out.
Regional Bank Crisis
Why did Silicon Valley Bank (SVB) fail? SVB was different than many other regional banks as they built relationships with venture capital firms. These companies are start-up businesses that are typically too risky for most regional banks to have as a large percentage of their client base. SVB had a concentration of deposits from venture cap clients. The venture capital companies started withdrawing large sums of money from the bank either to help run their business or to seek higher returns than the bank was offering. This caused SVB to sell a large portion of their longer duration bond portfolio to fund the withdrawals. When interest rates rise, bond prices fall. When SVB sold their bonds, they incurred a loss of $1.8 billion which then led depositors to withdrawal their deposits and place them with more stable institutions. The result was SVB failing and federal regulators taking control. This sent a ripple through many of the regional banks, as investors withdrew their funds to place deposits with safer national banks or brokerage houses. Even though many regional banks did not have a large portion of venture capital clients, the perception of weakness led to a run on these banks. Stock prices for many regional banks are off massively as concerns linger.
The S&P 500 marched higher in the first quarter returning 7.5%. While most sectors experienced positive performance, Information Technology led the way returning over 20%. Communication service and Consumer Discretionary sectors were also up significantly returning more than 15%. Financials were the worst performing sector down 5%.
In this current market environment, we are focusing on high quality companies with good revenue and cashflows to add to the portfolio. We added two new names this quarter and averaged down in another.
Industrials – We purchased a new position in Union Pacific Corporation (UNP). It is a railroad and freight company needed to move goods and people across the US. The company has very solid financials and cash flows have shown it to be a consistent grower. The price for the company was down about 15% from the prior year and we took the opportunity to add it to our portfolio.
Consumer Staples – Costco (COST) needs no introduction. It has been described as a place with everything you would ever need from birth to death. The quantity is large, quality is good, and you would be hard pressed to find lower prices elsewhere. Combine those qualities and the average shopper is spending hundreds of dollars every time they shop at Costco. And to top it off, it is typically crowded! For good reason, Costco trades at higher multiples and is not the type of value company that we normally purchase. However, as revenue, net income, and cash flows from operations continue to grow significantly through the years, we decided to add this quality company after it had a small pull back in price in the quarter.
Consumer Discretionary – Amazon is a company that we purchased previously. The stock got a bit ahead of itself and had a pullback in price last year of over 30%. We averaged down on this name for clients that had a higher entry point. Again, sticking with quality in this environment. Amazon continues to grow its funds from operations and is obviously very successful.
2023 has started out well for the stock market but there are still several unknowns that could affect market performance going forward. It seems as if every economist on TV is predicting a recession this year. It is possible. However, if inflation continues its downward trend, the Fed slows up on raising interest rates, and consumers don’t run for the exits, we may indeed make a soft landing. As we say every quarter, earnings matter. Expectations are lower, so exceeding expectations may be feasible. For the time being, we will continue to put a premium on quality when adding new positions to help soften any potential pitfalls of a falling market.
We expect the market will be choppy in the short-term. That is OK, as we invest with a long-term view and seek buying opportunities when short-term fear presents them. We thank you for your continued support in allowing us to help you to reach your financial goals.
Matt Johnson, CFA® - Andy Nugent, CFA®
Sage Capital Advisors, LLC is a Securities and Exchange Registered Investment Advisor. Sage Capital Advisors is headquartered in Sioux Falls, South Dakota. Advisory services are only offered to clients or prospective clients where representatives of Sage Capital Advisors are properly licensed or exempt from licensure. This market commentary is solely for informational purposes and should not be construed as investment advice, it is only intended to provide education about the financial industry. Historical performance results for investment indices and/or categories have been provided for general comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of investment management fees, or the impact of taxes, all of which would have the effect of decreasing historical performance results. Indices are unmanaged and cannot be invested in directly. It should not be assumed that your account holdings correspond directly to any comparative indices. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered unless a client service agreement is in place.