As we near the close of the first quarter, the Federal Reserve's fight to tame inflation continues to rule the markets.
Dashing some hopes for a pause, the Fed announced another 25-basis-point rate hike this week as it reaffirmed its commitment to bringing inflation down. However, Federal Reserve Chair Jerome Powell said that in assessing the need for further hikes, the Fed would be keeping an eye on the "actual and expected effects" from the fallout after the sudden failures this month of Silicon Valley Bank (SVB) and Signature Bank. He said the Fed is focused on the fact that tightening in credit conditions can bring inflation down, and if that transpires in the wake of SVB's collapse, further hikes might not be needed.
This was a slight reset from Powell's comments earlier this month, when he suggested that rates may need to go even higher than initially expected, and for longer, to curb stubborn inflation. That sparked a major sell-off on Wall Street that brought the Dow into negative territory for 2023, fully reversing course after equities saw a strong start to the year.
Indeed, the January Effect was in full force as we kicked off this quarter, which isn't surprising after the amount of tax-loss selling at the end of last year. Everything that didn't work in 2022 actually reversed course in January. All of 2022's biggest laggards rallied in the first month of the year only to quickly reverse course again in February.
Amid the mixed signals on inflation and the economy and expectations for a slowdown, I continue to see opportunities. I am looking at a blend of cyclicals, value and some beaten-down growth stocks. I remain focused on high-quality, blue chip companies with high levels of free cash flow (FCF).
Banking Turmoil
This month we saw the collapse of Silicon Valley Bank, Signature Bank and Credit Suisse. This fueled anxiety about other regional banks. While the potential damage to confidence levels and risk of contagion are hard to predict, I would argue that these three banks had issues well before the Fed started hiking rates.
Credit Suisse had been a problem bank for 15 years as European regulators didn't require the same levels of capital at their banks after the global financial crisis. SVB had a heavy mix of venture capital deposits and made a bad bet on the fixed income book. And Signature Bank was too heavily exposed to crypto. We will continue to watch the regional banks, deposit flows and confidence, but we are finding opportunities in some of the large, mega-cap bank stocks, which will benefit from this fallout.
The surprise this year so far has been the resiliency in the economy. Consumer and producer price index data continues to be solid, along with core retail sales in February. Simply put, growth in the economy continues to chug along, which is propping up inflation. Fed policymakers have raised rates by 475 basis points over the past 12 months, and that will eventually slow the economy and inflation, but as of now, it hasn't happened.
