Investment Perspectives April 2023

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I N V E S T M E N T S T R AT E G Y G R O U P

INVESTMENT PERSPECTIVES
APRIL 2023

Key Takeaways —
• A n examination of whether the recent • Is the shape of the yield curve a • S econd quarter begins with some
bank failures carry further implications sign of an imminent recession, or valuable lessons for investors.
for the economy. a false positive?

BANK FALLOUT RISKS ECONOMIC CONTAGION


Mark Luschini, Chief Investment Strategist
twitter.com/luschini_janney
The economic landscape Treasury officials, regulators, investors, and customers have
continues to wrinkle as the focused their attention on the vulnerabilities of small and
lagged effect of the Federal mid-sized banks.
Reserve’s rate hike in March
2022—the first since 2018—and Banks with less than $250 billion in assets are home to
subsequent hikes gain traction. nearly half of domestic deposits and account for about
half of commercial and industrial lending, as well as over
In last month’s issue, we discussed the strength of the half of mortgage and commercial real estate lending.
labor market as the key to postponing a recession, should Banks are the primary artery of the U.S. economy,
one develop resulting from the Federal Reserve’s rate- therefore new constraints on their profitability—whether
hiking campaign designed to thwart inflation by cooling it be through stricter regulations, more conservative
demand. While we continue to believe that to be the business practices, higher deposit rates to hold or lure
case, recent events unfolding in the banking sector have customers, or just the overarching risk of an economic
presented a new twist to evaluate in the context of its slowdown or recession—will likely dampen credit
spillover to the broader economy. expansion in some way. Growth could wither, although
it might not manifest by way of an immediate decline in
Certainly, we are not expecting a repeat of the global economic activity and the Federal Reserve’s increasingly
financial crisis (GFC) that rattled financial markets and restrictive monetary setting.
economies alike some 15 years ago. Instead, we are
assessing the fallout from the bank failures that have The most recent Senior Loan Officer Opinion Survey
occurred recently to consider what economic contagion, conducted by the Federal Reserve showed lending
if any, may spread. standards tightening for both businesses and consumers.
That, in and of itself, is not unusual as periods of loose
Very Different from ’08 credit and low lending rates breed borrowing that
eventually begins to stress as an economy slows.
Unlike the GFC, the trouble in the banking sector that
appeared in March had little to do with the housing market. While delinquency rates have started to move higher, it is
Instead, putting aside the supervisory issues associated with coming from near a historically low level. Still, if or when
risk management and regulatory oversight, it was caused lending conditions tighten further, the impact could be
by the rapid pace of monetary tightening that exposed an felt via an uptick in unemployment as funds for business
asset/liability duration mismatch that was exacerbated by an projects dry up, the cost of capital rises and pressures
eroding deposit base. This characteristic exists across many corporate margins, or loan demand stalls as consumers
financial institutions (the exceptions being the largest banks defer purchases of big-ticket items because of high and
that tend to have more diversified businesses), and thus rigid borrowing costs.

© JANNEY MONTGOMERY SCOTT LLC • MEMBER: NYSE, FINRA, SIPC • INVESTMENT PERSPECTIVES, APRIL 2023 • REF: 1036500-0423 • PAGE 1 OF 5
The Takeaway for Investors
The quandary for equity investors is allocating capital for
the competing prospects of dissipating inflation concerns
but slowing growth against the possible avoidance of a
recession, which could happen if growth stays resilient
and the banking fervor is properly ring-fenced.
Playing both sides through a conservative and prudently
allocated portfolio—a posture we have advocated for the
last few months—continues to be sensible in our view given
the aforementioned uncertainties that are far from resolved.
We will tactically adjust our risk budget as we develop
higher confidence in the path the economy will take.
Stay tuned.

© JANNEY MONTGOMERY SCOTT LLC • MEMBER: NYSE, FINRA, SIPC • INVESTMENT PERSPECTIVES, APRIL 2023 • REF: 1036500-0423 • PAGE 2 OF 5
A VOLATILE YIELD CURVE
Guy LeBas, Chief Fixed Income Strategist
twitter.com/lebas_janney

For decades, investors and predicting a recession. Incidentally, while we used the 2s/10s
economists have relied on the spread as an inversion measure, academic studies have
shape of the yield curve as suggested the 6-month/2-year spread is timelier, and that
an indicator of fundamental spread too is inverted.
growth prospects and
financial risk-taking. We can imagine one escape path in 2023: Inflation is high
but falling, and the U.S. could skirt recession if inflation fell
During the course of the last 12 months, that shape quickly enough. Since recessions are typically triggered
has changed wildly—as fast as at any point in the last by negative real economic growth (nominal economic
40 years. For simplicity’s sake, we often focus on the growth minus inflation), if inflation drops faster than
difference between 2-year and 10-year maturities in nominal growth slows, real growth could remain positive,
evaluating the shape of the yield curve, also known as and the Fed might still cut rates. In that scenario, the
the “2s/10s spread.” bond markets’ inversion would still be “correct,” but the
economic outcome would be benign. There is a chance
As Chart 1 highlights, 10-year yields have been above
of this “Goldilocks” scenario evolving, but it requires
2-year yields for about 92% of the months since the late
several unlikely things to happen at once.
1970s. Since June 2022, however, the 2s/10s spread has
been “inverted” with 10-year yields below 2-year yields.
Bond Market Gauge
Historically, an inversion has indicated high likelihood
(though not certainty) of a significant economic slowdown The extreme volatility in the shape of the yield curve—a
or recession on the horizon. better timing tool than inversion alone—is bond market
Chart 1: 2s/10s Spread Has Been Positive in 510 of 550 Months evidence that does signal impending economic stress.
When Negative, Good Chance of Recession
Chart 2: When 2s/10s Spread is Negative and Volatile, Recession is
Typically Close

Source: Janney Investment Strategy Group; Bloomberg

Source: Janney Investment Strategy Group; Bloomberg

Sign of a Slowdown?
The 2s/10s spread has been swinging wildly during the
Although an inverted yield curve indicates a good first quarter of 2023, starting at -0.55%, notching a low
chance of recession, the signal has issued a handful of of -1.08% in early March, and finishing again at -0.55%.
false positives, making it a “necessary but not sufficient” With the exception of the sudden stop during the 2020
condition for a slowdown. Moreover, inversion is a terrible recession, each economic downturn over the past 45
timing tool, as the period between inversion and recession years was preceded by a negative 2s/10s spread, plus
(if it happens) varies widely. a doubling in spread volatility.
A better way to think of a yield-curve inversion is as a signal The median time between increased volatility and recession
about Federal Reserve policy. When short-term rates are onset was three months, with a range of one to four months,
higher than long-term ones, the bond market is telling us the and there have been three false positives. No economic
Fed has set overnight interest rates at a contractionary level indicator is perfect, and perhaps 2023 is the time that breaks
and will probably have to cut those rates. The Fed typically this one’s track record, but the bond market is decidedly
cuts rates in the face of a recession, so it follows then that flashing amber on recession risk.
a yield-curve inversion is correlated with bond markets

© JANNEY MONTGOMERY SCOTT LLC • MEMBER: NYSE, FINRA, SIPC • INVESTMENT PERSPECTIVES, APRIL 2023 • REF: 1036500-0423 • PAGE 3 OF 5
LESSONS APPARENTLY NEVER LEARNED
Gregory M. Drahuschak, Market Strategist
Advice most often attributed to Second Quarter Begins
Winston Churchill says: “Those
that fail to learn from history April trading began after the S&P 500 spent March exceeding
are doomed to repeat it.” In the levels of potential technical resistance at its 200- and 50-day
investment world, not learning moving averages and 4,050 before moving toward 4,100,
from history can be costly. where the index might reach an overbought condition.
Chart 3: Year-to-Date 2023 Sector Percentage Changes
Of all the mistakes investors might make, reaching too far
for yield is the worst and it often occurs in situations least
able to withstand the potentially negative consequences.

Steering Clear of Costly Mistakes


In an attempt to deflect blame, defenders of Silicon Valley
Bank argued that the bank’s demise largely was the result
of the rapid rise in interest rates that sank the open-market
value of its bond holdings. However, in the end, the bank’s
desire to reach for more yield allowed it to ignore some of
the basic principles of banking and investing.
After suffering through historically low fixed-income yields, Source: Janney Investment Strategy Group

investors seeking income now have access to reasonable


returns from sources like Treasury notes and bonds, high-
For a year, the equally weighted S&P 500 ETF, RSP,
quality corporate bonds, and municipal bonds. Hopefully,
outperformed the capitalization-weighted S&P 500. This
this will allow large and small investors to avoid another
changed last month as the market’s highest-profile names
scheme that promises to vastly improve their income. Our
in the Technology, Communication Services, and Consumer
fear is that it will not.
Discretionary sectors reasserted their dominance after
Corporate income will be on investors’ minds in the middle having suffered some of the largest drops in the previous
of April as companies begin to report their calendar first- 15 months. If this shift in market emphasis continues, it
quarter results. This takes on greater significance after the could be a key factor in coming months, prompting large
2023 S&P 500 earnings estimate has fallen in 26 of the portfolio adjustments that raise the market’s risk profile.
last 28 weeks.
The March Investment Perspectives ended with the
April often is an important month for the stock market suggestion that the S&P 500 will be contained within
because it is second only to December in terms of the the 3,800-4,200 range. In our view, the market’s solid
number of times since 1950 that the month has ended with close to the first quarter does not alter thinking that this
the S&P 500 posting a gain. April also has had the third-best range is likely to persist unless the coming earnings
monthly price performance. Since 1950, the S&P 500 has season produces better-than-currently-expected results.
had a pre-election-year loss in April only once. The second However, it does not look like the S&P 500 Index’s 2023
quarter of the midterm election period also is a potential earnings estimate has reached a bottom yet.
positive because, on average, the S&P 500 gains 4.5%.
Since 1950, it has been the second-best month in terms of
frequency of gains.
However, April is also the final month of what typically is the
market’s best six-month period. Since 1950, the S&P 500
has posted an average gain of 7% from November through
April, while the S&P 500, from October through May, has
averaged only a 1.5% gain, which is what created the “sell in
May and go away” cliché.
Within the May-through-October period, the S&P 500 fares
best in October (average gain of 0.86%), with September
posting the worst average loss (down 0.69%).

© JANNEY MONTGOMERY SCOTT LLC • MEMBER: NYSE, FINRA, SIPC • INVESTMENT PERSPECTIVES, APRIL 2023 • REF: 1036500-0423 • PAGE 4 OF 5
DISCLAIMER
The information herein is for informative purposes only and in no event should be construed as a representation by us or as an offer to sell, or solicitation of an
offer to buy any securities. The factual information given herein is taken from sources that we believe to be reliable, but is not guaranteed by us as to accuracy
or completeness. Charts and graphs are provided for illustrative purposes. Opinions expressed are subject to change without notice and do not take into
account the particular investment objectives, financial situation or needs of individual investors.

The concepts illustrated here have legal, accounting, and tax implications. Neither Janney Montgomery Scott LLC nor its Financial Advisors give tax, legal, or
accounting advice. Please consult with the appropriate professional for advice concerning your particular circumstances. Past performance is not an indication
or guarantee of future results. There are no guarantees that any investment or investment strategy will meet its objectives or that an investment can avoid
losses. It is not possible to invest directly in an index. Exposure to an asset class represented by an index is available through investable instruments based on
that index. A client’s investment results are reduced by advisory fees and transaction costs and other expenses.

Employees of Janney Montgomery Scott LLC or its affiliates may, at times, release written or oral commentary, technical analysis or trading strategies that differ
from the opinions expressed within. From time to time, Janney Montgomery Scott LLC and/or one or more of its employees may have a position in the securities
discussed herein.

© JANNEY MONTGOMERY SCOTT LLC • MEMBER: NYSE, FINRA, SIPC • INVESTMENT PERSPECTIVES, APRIL 2023 • REF: 1036500-0423 • PAGE 5 OF 5

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