We have been saying for a while now that the Federal Reserve’s accelerated and aggressive interest rate increases risk breaking something. The first instance of that happened March 10, when Silicon Valley Bank failed, followed by the failure of Signature Bank and then Credit Suisse overseas. Thankfully, the Fed had learned from the 2008 crisis and swept in with alacrity: They closed the troubled banks, reassured all their depositors (both insured and uninsured) and set up special facilities to provide liquidity to all stressed banks.
Overall, the markets and our client portfolios fared relatively well in the first quarter, with significant gains in both stocks and bonds. On the plus side, we are likely closer to the end of interest increases, and the pace of inflation seems to be decelerating. But we cannot rule out more financial stress spilling over into other parts of the financial markets.
In our Q2 2023 Commentary, we suggest that the recent bank failures are best assessed in the context of a new market regime, which is defined by higher inflation and interest rates than in the past 10-15 years, and a material shift in geopolitics. While such transition periods usually bring with them a higher steady state of risk, the flipside of risk is opportunity as asset prices become dislocated from their fundamentals and new secular growth trends emerge.
Eyes on the Prize
A key point that I think is again worth stressing is the importance of maintaining diversified portfolios during times of greater uncertainty. Well-orchestrated diversification inherently acts as a ballast during market turbulence. Even when asset prices are all moving down at the same time, like they were last year, the level of change varies among asset classes and provides some buffer. Diversification also allows some measure of protection from inflation as well as the potential to benefit from falling interest rates when that eventually happens.
As with the multiple universes presented in the Oscar-winning movie “Everything Everywhere All at Once,” market outcomes are not linear. There are many, many different variables and factors that bounce off each other to affect pricing and outcome. If the Fed itself cannot see where the economy is heading, we think best policy is to be prepared for many different outcomes.
What does that mean? First and foremost, it means invested to achieve your long-term goals based on the risk each client can, should and want to take, which by definition looks past relative quarterly returns. Secondly, it means owning exposures that could be well-positioned to take advantage of new opportunities as they emerge. And third, it means invested in a way that provides a smoother ride during periods of heightened market volatility. Those are our primary guides in making investment decisions on our clients’ behalf, regardless of the market environment.
