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Almost half-way through 2023, the stock market is outperforming most analysts’ expectations as earnings rebounded nicely and equity indices are mostly positive. The most popular domestic equity benchmark, the S&P 500, is up 9.7% for the year as of May 31st, a solid bounce back from 2022’s 18.1% decline.

In our Annual Outlook for 2023, we raised the possibility that the US economy could potentially avert recession in 2023, powered by full employment and robust consumer spending. Thus far, with roughly a month left in the 2nd quarter, the US economy has proven itself surprisingly resilient, with GDP growth of 1.3% in Q1 and unemployment at just 3.4% in April.

If you are a long-term investor, you most likely have your portfolio allocated in a diversified manner, with equity exposure that extends beyond the US borders to include foreign Developed Market (DM) and possibly Emerging Market (EM) exposure.

While the Federal Reserve has not explicitly stated it, May’s interest rate hike may well have been the final increase in the current cycle. If so, we have just witnessed one of the steepest rate hike cycles in history, with ten consecutive rate increases bringing the Fed Funds rate from its starting range of 0.0%-0.25% in March 2022 to 5.0%-5.25% as of May 2023.

We are presumably at the end stages of the Federal Reserve’s interest rate hike cycle, which has seen the central bank increase rates at the quickest pace in its history. The rapid rate hikes are intended to cool economic growth, and investors have been nervously speculating about where the impact of the rate hikes would first appear.

Financial news tends to lean negative, attributable to a mix of good risk-management (as investors we need to try to understand “all” the scenarios and plan accordingly for many contingencies) and the simple fact that ominous-sounding headlines attract eyeballs, which in turn drives higher advertising revenues.

“Risk” is a something of a loaded word, having a somewhat negative implication. Most people only focus on the downside risk, and when we hear about “risky” investments it is typically in reference to penny stocks, cryptocurrencies, and other speculative instruments.

We began the year with a mismatch in expectations between the market and the Federal Reserve (“the Fed”) regarding the projected path for interest rates. The Fed had penciled in a target terminal rate between 5-5.25%, which it planned on holding for the remainder of the year.

The recent banking crisis has immediately lowered expectations for future inflation expectations and interest rate hikes. Why? There is a direct correlation between economic activity and loan volume, and loan volume is destined for a short term contraction, at a minimum, as the regional banks, and even the big money center banks, reassess their positions and await whatever revised government regulation comes out of this banking crisis.

If you have tuned in to financial news, or any news for that matter, you are likely aware of the turmoil which began last week in the regional banking sector. It started when Silvergate Capital, a central lender to the cryptocurrency industry, sought a $2.25 billion loan to shore up its balance sheet. The move raised questions about the bank’s financial strength and triggered $42 billion in withdrawals.