Data Point– Fewer Shipping Containers Arriving at U.S. Ports

This month’s chart explores an alternative dataset, the number of shipping containers coming into U.S. ports. Alternative datasets like this are often used by institutional investors, such as hedge funds, to identify patterns and trends that may not be visible in traditional economic datasets. Why are shipping containers relevant? The volume of loaded container imports can act as a predictor of upcoming economic activity, as they represent expected demand for goods, which is closely connected to consumer spending and overall economic growth.

Figure 1 graphs the total loaded container imports across six major U.S. ports every month for the last five years. The years 2018 and 2019 establish a pre-pandemic baseline, including seasonal trends, for monthly container imports. Container volumes were normal in January 2020 but then plunged in February and March and remained weak for multiple months as the pandemic shut down the global economy. Import volumes rebounded in the second half of 2020 as the economy reopened and remained above-average in 2021 as consumers spent heavily on goods. Container volumes peaked in May 2022, but since then, have declined in seven of the last nine months. February 2023’s import volume was the third lowest month in the last five years, behind only February and March 2020 in the early months of the pandemic.

What is the data telling us? Fewer container imports indicate the economy is reverting to pre-pandemic norms. This drop could help alleviate supply chain bottlenecks and ease inflationary pressures, a positive development after inflation rose to a 40-year high during the pandemic. In addition, the decline in container imports may provide insight into upcoming economic trends. Businesses typically import less goods when demand is anticipated to decline, and declining imports could be an indication that businesses expect economic activity to slow. The question is whether the drop in shipping container volume is related to seasonal trends or the Federal Reserve’s interest rate hikes, which are designed to ease inflation by reducing demand.

Important Notices & Disclaimer

The information and opinions expressed herein are solely those of PFG Private Wealth Management, LLC (PFG), are provided for informational purposes only and are not intended as recommendations to buy or sell a security, nor as an offer to buy or sell a security. Recipients of the information provided herein should consult with their financial advisor before purchasing or selling a security.

The information and opinions provided herein are provided as general market commentary only, and do not consider the specific investment objectives, financial situation or particular needs of any one client. The information in this report is not intended to be used as the primary basis of investment decisions, and because of individual client objectives, should not be construed as advice designed to meet the particular investment needs of any investor.

The comments may not be relied upon as recommendations, investment advice or an indication of trading intent. PFG is not soliciting any action based on this document. Investors should consult with their financial adviser before making any investment decisions. There is no guarantee that any future event discussed herein will come to pass. The data used in this publication may have been obtained from a variety of sources including U.S. Federal Reserve, FactSet, Bloomberg, Bank of America Merrill Lynch, iShares, Vanguard and State Street, which we believe to be reliable, but PFG cannot be held responsible for the accuracy of data used herein. Any use of graphs, text or other material from this report by the recipient must acknowledge MarketDesk Research as the source. Past performance does not guarantee or indicate future results.   Investing   involves   risk,   including   the possible loss of principal and fluctuation of value. PFG disclaims responsibility for updating information. In addition, PFG disclaims responsibility for third-party content, including information accessed through hyperlinks.

No mention of a particular security, index, derivative or other instrument in the report constitutes a recommendation to buy, sell, or hold that or any other security, nor does it constitute an opinion on the suitability of any security, index, or derivative. The report is strictly an information publication and has been prepared without regard to the particular investments and circumstances of the recipient.

READERS   SHOULD   VERIFY   ALL   CLAIMS   AND   COMPLETE    THEIR    OWN RESEARCH AND CONSULT A REGISTERED FINANCIAL PROFESSIONAL BEFORE INVESTING IN ANY INVESTMENTS MENTIONED IN THE PUBLICATION. INVESTING IN SECURITIES AND DERIVATIVES IS SPECULATIVE AND CARRIES A HIGH DEGREE OF RISK, AND READERS MAY LOSE MONEY TRADING AND INVESTING IN SUCH INVESTMENTS.

PFG Private Wealth Management, LLC is a registered investment advisor.

1Q 2023 Recap & 2Q Outlook

Financial Markets Start 2023 Strong But End the First Quarter on a Question Mark

First quarter economic data showed the U.S. economy entered 2023 with considerable momentum, even in light of the Federal Reserve’s interest rate hikes throughout 2022. Fourth quarter 2022 GDP data showed the U.S. economy grew at a +2.6% rate. The growth was largely driven by a resilient consumer, inventory restocking, and increased government spending, while businesses cut back their spending and the housing market remained weak. Additional economic data in Figure 1 highlights the broad economic trends. Jobs remain plentiful with job openings significantly above pre-pandemic trend, inflation is easing, and consumer spending remains above trend. The data shows growth is normalizing as the economy returns to its pre-pandemic trend but suggests the economy is withstanding higher interest rates thus far.

Financial markets turned rocky during the last month of the quarter. Three regional banks failed, and the U.S. Treasury bond market became more volatile as investors debated whether the Federal Reserve would continue to raise interest rates against an uncertain backdrop. This quarter’s recap discusses recent bank failures, including concerns about financial stability, and provides an update on year-to-date stock and bond returns.

Regional Banks Fail After Sudden Withdrawal Spree

Three regional banks failed in March as the banking industry faced a crisis of confidence and customers quickly withdrew deposits. The top chart in Figure 2 (next page) shows deposits at U.S. commercial banks rose from $13.2 trillion at the end of 2019 to a peak of $18.1 trillion in April 2022 as businesses and individuals flooded banks with new deposits during the pandemic. More recently, deposits at commercial banks decreased in 9 of the last 12 months. The bottom chart in Figure 2, which graphs the change in bank deposits from peak levels, shows total U.S. commercial bank deposits have declined -$607 billion since April 2022. The decline marks the biggest banking sector deposit outflow on record and is starting to stress bank balance sheets.

To meet withdrawal requests, banks maintain a portion of their assets as liquid reserves, such as government bonds and commercial paper, that can quickly be converted to cash. If banks exhaust the liquid reserves, they can either borrow from other banks and the Federal Reserve or sell assets, such as their bond holdings. This basic process helps explain why three banks failed.

Depositors overwhelmed the banks in early March with withdrawal requests. The banks exhausted their liquid reserves, could not obtain loans from other banks or the Federal Reserve in a time-efficient manner, and were forced to sell their most liquid assets, which consisted of U.S. Treasury bonds and mortgage-backed securities. The problem for the banks is interest rates are significantly higher than when the banks bought the bonds, and the bonds are now worth less. When the banks sold the bonds, the were forced to realize billions of dollars of losses, which drained their capital cushions and made them technically insolvent. State banking regulators and the FDIC immediately stepped in to take over the failed banks and protect depositors.

These recent bank failures have raised concerns about financial stability and drawn comparisons to 2008. However, there are important differences from 2008, including both regulatory changes and the causes of insolvency. Banking reforms after the 2008 crisis strengthened the overall financial system, and higher capital requirements now provide banks with a more robust financial cushion. In addition, regulators now possess greater authority to resolve issues in large, failed banks in order to avoid chaotic situations like the Lehman Brothers bankruptcy. In terms of cause, the 2008 crisis was primarily triggered by bad loans and complex securities. In contrast, recent bank failures resulted from the Federal Reserve’s rapid interest rate increases, which created paper losses for banks that made loans or purchased bonds at lower interest rates.

Navigating the Volatile Interest Rate Landscape

The Treasury market is experiencing more volatility and illiquidity because of conflicting signals about the strength of the U.S. economy and the Federal Reserve’s policy plans. Solid economic data in January showed the U.S. economy coping well with rising interest rates, suggesting the Federal Reserve may need to do more than anticipated to ease inflation. During early March congressional testimony, Federal Reserve Chair Jerome Powell spooked markets by suggesting the central bank would need to raise interest rates higher than initially thought and then keep interest rates higher for longer. The warning caused Treasury yields to rise and bonds to trade lower. Less than one week after Powell testified, multiple regional banks collapsed, causing worries about the U.S. financial system’s stability. Treasury yields reversed course and declined, causing bonds to trade higher. The two conflicting themes have resulted in wild price swings in the usually quiet Treasury market as traders place bets on the likelihood of future rate cuts.

Figure 3, which graphs the rolling 2-day percentage change in the 2-year U.S. Treasury yield, shows the recent spike in volatility. Taller bars indicate the 2-year Treasury yield experienced a bigger 2-day move. The chart looks like a heartbeat over the past 12 months, going up and down with occasional volatility as markets responded to new information. However, the far right of the chart shows a spike in both directions recently. The 2-year yield plunged -0.87% on March 13th after two regional banks failed over the weekend, its biggest 2-day decline since the Black Monday stock market crash in October 1987. After banking regulators took over control of the banks and the Federal Reserve introduced lending programs to stabilize the banking sector, the 2-year yield surged +0.35% on March 21st.

What is causing the volatility? Investors now fear the Federal Reserve faces a tough set of choices. The central bank must balance bringing inflation under control with minimizing damage to the U.S. economy. One factor complicating the central bank’s task and contributing to interest rate volatility is the lagged effect of monetary policy – it is difficult to model how 2022’s interest rate hikes already have and will impact the economy. As a result, there is little consensus inside the Federal Reserve on the path of monetary policy. The central bank’s Summary of Economic Projections, which provides forecasts for key economic indicators and offers insights into the future direction of monetary policy, shows a wide range of interest rate projections. Projections for interest rates at the end of 2024 range from 3.4% to 5.6%, while the 2025 projection range is 2.4% to 5.6%. With even the Federal Reserve uncertain about policy, interest rates could remain volatile in the coming quarters.

How does the volatility impact businesses, consumers, and investors? Treasury securities are considered safe-haven assets, used as collateral for loans and other debts, and serve as a benchmark for pricing other financial securities, such as corporate and municipal bonds, mortgages and other asset-backed securities, and money market instruments. Increased volatility and illiquidity can disrupt the flow of credit, making it more challenging to price loans and various other financial products. While current volatility is linked to uncertainty about Federal Reserve policy rather than financial system stress, the risk is interest rate volatility spreads to other corners of financial markets. For businesses and consumers, this could mean higher financing costs and more difficulty obtaining loans. For investors, this could mean borrowers are unable to refinance their maturing bonds and end up defaulting on their principal and interest payments.

Equity Market Recap – A Reversal in Performance Trends During the First Quarter of 2023

Stocks traded higher in January before giving up some of their gains in February and March. The S&P 500 Index of large cap stocks ended the first quarter up +7.4%, outperforming the Russell 2000 Index’s +2.7% return. Most of the S&P 500’s relative outperformance occurred in March as investors de-risked their portfolios following the bank failures. There was also a sizable shift in factor performance during the first quarter. The Russell 1000 Growth Index gained +14.3%, outperforming Russell 1000 Value’s +0.9% return. Like the S&P 500, the Growth factor’s relative outperformance occurred in March after the bank failures. Growth stocks tend to be higher quality businesses with stronger fundamentals, and recent bank failures may have motivated investors to rotate into higher quality companies. Regardless of the cause, Growth’s outperformance is a significant change from 2022 when the Federal Reserve’s interest rate increases weighed on expensive stock valuations.

The Growth vs Value performance reversal also shows up in first quarter sector returns, with Growth-style sectors outperforming. Figure 4 is a scatterplot that compares each sector’s 2022 return (vertical y-axis) against its first quarter 2023 return (horizontal x-axis). In general, the worst performing sectors in 2022 are the top performing sectors in 2023, while 2022’s top performing sectors are broadly underperforming to start 2023. Beyond the year-to-date performance reversal, there was no obvious preference for defensive or cyclical sectors.

Turning to global markets, international stocks posted positive returns during the first quarter. The MSCI EAFE Index of developed market stocks gained +9.0%, outperforming the MSCI Emerging Market Index’s +4.1% return. Europe was the top performing international region and boosted developed markets’ performance. The region managed to avoid a major energy crisis during the winter months thanks to unseasonably warm weather and efforts to secure alternative natural gas sources after Russia cut off most of its supply. Short-term gas prices have fallen from record highs, preventing severe shortages and rationing, although utility bills remain high. In Asia, all eyes remain on China as the country reopens after relaxing its Covid-zero restrictions. The reopening is expected to boost China’s economy, and potentially the global economy, but it is unclear how strong or lasting the growth will be.

Bond Market Recap – Riskier Bonds Underperform Due to Concerns About Refinancing Risk

Bonds traded in both directions during the first quarter, initially trading higher in anticipation of the end of the tightening cycle before trading back lower as the Federal Reserve hinted at higher interest rates for longer. Corporate investment grade bonds ended the first quarter with a +4.6% total return, outperforming corporate high yield’s +3.7% total return. Like equities, investment grade’s outperformance primarily occurred in March after bank failures raised concerns of increased default risk.

Tighter bank lending standards are becoming a concern in credit markets. For perspective, banks aggressively tightened lending standards during the last 12 months in anticipation of the Federal Reserve’s interest rate hikes slowing economic growth. With recent bank failures causing banks to question the stability of checking deposits, there is a risk that banks will adopt a more cautious approach to lending and reduce the total amount of credit they offer. The decreased credit supply and access to credit could have a domino effect, impacting the economy and financial markets over time. Borrowers, specifically high-yield issuers, could default on their debt if it becomes difficult and too expensive to refinance their maturing loans. Credit markets will be watching for signs of refinancing stress in the coming months.

Second Quarter Outlook – Back to the Fundamentals

The outlook is indecisive as financial markets close out the first quarter of 2023. Some investors believe the Federal Reserve’s actions will slow economic growth and tip the U.S. economy into a recession. This group points to recent bank failures as a warning sign that higher interest rates will have a negative impact. In contrast, some investors believe the U.S. economy is strong enough to withstand the Fed’s actions. This group points to first quarter economic data as a sign of strength and banking regulators’ actions as an indication the U.S. financial system is functioning as intended.

The back and forth is likely to continue until some of the market’s most pressing questions are answered. Key questions include the direction of Federal Reserve policy, the stability of the U.S. banking sector, inflation’s stickiness, corporate earnings growth, and the strength of the U.S. economy. Our team will be monitoring the answers to these questions in coming months to help guide investment portfolio positioning, with first quarter earnings season scheduled to start in mid-April.

As we have mentioned previously, the current investing environment requires a long-term outlook. Trend changes are frequent, fast, and driven by fluctuating market headlines, and keeping up with the day-to-day whims of the market can be emotionally taxing. Developing a financial plan and sticking to it are important steps to achieving your financial goals. Do not hesitate to reach out to our team if you have any questions or concerns about your financial plan or situation.

Important Notices & Disclaimer

The information and opinions expressed herein are solely those of PFG Private Wealth Management, LLC (PFG), are provided for informational purposes only and are not intended as recommendations to buy or sell a security, nor as an offer to buy or sell a security. Recipients of the information provided herein should consult with their financial advisor before purchasing or selling a security.

The information and opinions provided herein are provided as general market commentary only, and do not consider the specific investment objectives, financial situation or particular needs of any one client. The information in this report is not intended to be used as the primary basis of investment decisions, and because of individual client objectives, should not be construed as advice designed to meet the particular investment needs of any investor.

The comments may not be relied upon as recommendations, investment advice or an indication of trading intent. PFG is not soliciting any action based on this document. Investors should consult with their financial adviser before making any investment decisions. There is no guarantee that any future event discussed herein will come to pass. The data used in this publication may have been obtained from a variety of sources including U.S. Federal Reserve, FactSet, Bloomberg, Bank of America Merrill Lynch, iShares, Vanguard and State Street, which we believe to be reliable, but PFG cannot be held responsible for the accuracy of data used herein. Any use of graphs, text or other material from this report by the recipient must acknowledge MarketDesk Research as the source. Past performance does not guarantee or indicate future results.   Investing   involves   risk,   including   the possible loss of principal and fluctuation of value. PFG disclaims responsibility for updating information. In addition, PFG disclaims responsibility for third-party content, including information accessed through hyperlinks.

No mention of a particular security, index, derivative or other instrument in the report constitutes a recommendation to buy, sell, or hold that or any other security, nor does it constitute an opinion on the suitability of any security, index, or derivative. The report is strictly an information publication and has been prepared without regard to the particular investments and circumstances of the recipient.

READERS   SHOULD   VERIFY   ALL   CLAIMS   AND   COMPLETE    THEIR    OWN RESEARCH AND CONSULT A REGISTERED FINANCIAL PROFESSIONAL BEFORE INVESTING IN ANY INVESTMENTS MENTIONED IN THE PUBLICATION. INVESTING IN SECURITIES AND DERIVATIVES IS SPECULATIVE AND CARRIES A HIGH DEGREE OF RISK, AND READERS MAY LOSE MONEY TRADING AND INVESTING IN SUCH INVESTMENTS.

PFG Private Wealth Management, LLC is a registered investment advisor.

A Simple Explanation of Recent Bank Failures

The banking industry is experiencing a crisis of confidence as checking deposits are withdrawn after businesses and individuals flooded banks with new deposits during the pandemic. Figure 1 shows deposits at commercial banks rose from $13.2 trillion at the end of 2019 to a peak of $18.1 trillion in the first half of 2022. The increase in deposits occurred as the Federal Reserve doubled the size of its balance sheet by $4.5 trillion, the federal government distributed multiple rounds of stimulus checks, and social distancing restrictions limited consumer spending on services. More recently, Figure 2 shows deposits at commercial banks decreased in 9 of the last 12 months. The decline in deposits is occurring as the Federal Reserve shrinks its balance sheet and inflation weighs on consumer savings. Banks complained about too many deposits in the past few years, but now declining deposits are starting to pressure some bank balance sheets.

Last week saw the failure of two California banks and one New York bank serving niche industries that benefited from the recent period of 0% interest rates. Silvergate and Signature Bank operated as bankers to the crypto industry, and Silicon Valley Bank (SVB) catered to the venture capital and startup ecosystem. All three banks experienced a surge in deposits during the pandemic for industry-specific reasons. Silvergate and Signature Bank took in deposits from crypto exchanges and other industry participants that lacked access to banks due to regulatory constraints. SVB’s deposits grew rapidly as startups raised money from venture capital firms and parked it at the bank.

Bank analysts point to the three banks’ business models and lack of diversification as the cause of their issues. From a business model standpoint, the banks quickly took in a surge of deposits. Instead of using those deposits to make new loans to consumers and businesses, the banks purchased U.S. Treasury bonds and agency mortgage-backed securities with relatively long maturities. The banks primarily purchased bonds with long maturities because the bonds offered significantly more interest income than short maturity bonds, which offered relatively low income due to the Federal Reserve keeping interest rates near 0% during the pandemic. The risk for the banks was that the Federal Reserve increased interest rates and the bonds lost value, which is exactly what happened.

Fast forward to the start of 2023, the three banks experienced a flood of withdrawal requests. To meet the deposit withdrawal requests, the banks were forced to sell assets, including the Treasury bonds and mortgage-backed bonds the banks bought when interest rates were lower. The problem for the three banks is interest rates are significantly higher than when the banks bought the bonds, which resulted in the banks realizing billions of dollars of losses. The realized losses drained the banks’ capital cushions, making the banks technically insolvent. Silvergate voluntarily ceased operations and plans to liquidate its assets, while Signature Bank and SVB were both taken over by the FDIC.

The three bank failures are a unique situation, because the banks did not have bad assets in the form of risky loans or complex derivatives. To the contrary, the banks primarily held safe assets in the form of U.S. treasuries and mortgage-backed bonds. The banks’ undoing appears to be related to a mismatch between their liabilities (which were the concentrated deposits from niche industries) and their assets (which were the bonds with long maturities). In our view, the lesson from the three bank failures is not that banks are sitting on risky loans and complex derivatives but rather that aggressively raising interest rates from 0% to above 4% stressed the banks balance sheets and could stress the wider financial system.

While the banks’ failures are concerning, it is important to note bank analysts believe this is a unique situation due to specific client bases and their balance sheets. Although other banks could face similar isolated issues, analysts believe most banks managed and matched their assets and liabilities better than the three banks that failed. However, investors, the Federal Reserve, and regulators will be watching for signs of stress across the financial system this year.

Important Notices & Disclaimer

The information and opinions expressed herein are solely those of PFG Private Wealth Management, LLC (PFG), are provided for informational purposes only and are not intended as recommendations to buy or sell a security, nor as an offer to buy or sell a security. Recipients of the information provided herein should consult with their financial advisor before purchasing or selling a security.

The information and opinions provided herein are provided as general market commentary only, and do not consider the specific investment objectives, financial situation or particular needs of any one client. The information in this report is not intended to be used as the primary basis of investment decisions, and because of individual client objectives, should not be construed as advice designed to meet the particular investment needs of any investor.

The comments may not be relied upon as recommendations, investment advice or an indication of trading intent. PFG is not soliciting any action based on this document. Investors should consult with their financial adviser before making any investment decisions. There is no guarantee that any future event discussed herein will come to pass. The data used in this publication may have been obtained from a variety of sources including U.S. Federal Reserve, FactSet, Bloomberg, Bank of America Merrill Lynch, iShares, Vanguard and State Street, which we believe to be reliable, but PFG cannot be held responsible for the accuracy of data used herein. Any use of graphs, text or other material from this report by the recipient must acknowledge MarketDesk Research as the source. Past performance does not guarantee or indicate future results.   Investing   involves   risk,   including   the possible loss of principal and fluctuation of value. PFG disclaims responsibility for updating information. In addition, PFG disclaims responsibility for third-party content, including information accessed through hyperlinks.

No mention of a particular security, index, derivative or other instrument in the report constitutes a recommendation to buy, sell, or hold that or any other security, nor does it constitute an opinion on the suitability of any security, index, or derivative. The report is strictly an information publication and has been prepared without regard to the particular investments and circumstances of the recipient.

READERS   SHOULD   VERIFY   ALL   CLAIMS   AND   COMPLETE    THEIR    OWN RESEARCH AND CONSULT A REGISTERED FINANCIAL PROFESSIONAL BEFORE INVESTING IN ANY INVESTMENTS MENTIONED IN THE PUBLICATION. INVESTING IN SECURITIES AND DERIVATIVES IS SPECULATIVE AND CARRIES A HIGH DEGREE OF RISK, AND READERS MAY LOSE MONEY TRADING AND INVESTING IN SUCH INVESTMENTS.

PFG Private Wealth Management, LLC is a registered investment advisor.

Global Markets Trade Higher to Start 2023

Monthly Market Summary

  • The S&P 500 Index returned +6.3% in January, underperforming the Russell 2000 Index’s +9.8% return. 2022’s underperforming sectors were the top performers in January, while defensive sectors posted negative returns.
  • Corporate investment grade bonds generated a +5.2% total return, outperforming corporate high yield bonds’ +3.7% total return. The positive bond returns occurred as Treasury yields declined across most of the yield curve.
  • International stocks outperformed for a third consecutive month as the U.S. dollar weakened. The MSCI EAFE Index of developed market stocks returned +9.0%, in line with the MSCI Emerging Market Index’s +9.1% return.

Fourth Quarter GDP Growth Slows but Remains Positive

The U.S. economy grew at a +2.9% annual rate in the fourth quarter of 2022, down from the third quarter’s +3.2% annual rate. The growth was largely driven by a resilient consumer, inventory restocking, and increased government spending, while businesses cut back their spending on equipment and the housing market remained weak. While GDP growth was positive for a second consecutive quarter, the pace of economic growth slowed as the year ended. The U.S. economy grew +1% year-over-year compared to the same quarter a year ago, a slowdown from the +5.7% year-over-year growth rate recorded in the fourth quarter of 2021.

The slowdown signals a return to a more normal pace of growth after 2021’s strong growth. Looking ahead to 2023, the U.S. economy is forecasted to slow as the cumulative effect of higher interest rates takes hold. Economists are concerned the Federal Reserve’s efforts to curb inflation could trigger further spending cutbacks and job losses and tip the U.S. into a recession.

Financial Conditions Loosen in Anticipation of 2023 Interest Rate Cuts

Financial conditions, which refer to the ease and cost of obtaining capital, loosened in January. The catalyst was the market’s anticipation of possible interest rate cuts in late 2023 due to a slowdown in economic activity. Treasury yields declined, corporate bond spreads tightened, and mortgage rates declined another -0.40%. Lower stock and bond market volatility, which reduces the level of perceived risk and encourages more investment activity, added to the loosening of financial conditions.

The Federal Reserve has expressed concern about the potential for loose financial conditions to undercut its efforts to bring inflation down. When financial conditions are loose, people are more willing to take risks and borrow money, which can lead to higher spending and demand for goods and services. This increased demand could drive up prices, keeping inflation elevated and forcing the Federal Reserve to tighten further. Policymakers will keep a close eye on financial conditions as 2023 progresses.

Important Notices & Disclaimer

The information and opinions expressed herein are solely those of PFG Private Wealth Management, LLC (PFG), are provided for informational purposes only and are not intended as recommendations to buy or sell a security, nor as an offer to buy or sell a security. Recipients of the information provided herein should consult with their financial advisor before purchasing or selling a security.

The information and opinions provided herein are provided as general market commentary only, and do not consider the specific investment objectives, financial situation or particular needs of any one client. The information in this report is not intended to be used as the primary basis of investment decisions, and because of individual client objectives, should not be construed as advice designed to meet the particular investment needs of any investor.

The comments may not be relied upon as recommendations, investment advice or an indication of trading intent. PFG is not soliciting any action based on this document. Investors should consult with their financial adviser before making any investment decisions. There is no guarantee that any future event discussed herein will come to pass. The data used in this publication may have been obtained from a variety of sources including U.S. Federal Reserve, FactSet, Bloomberg, Bank of America Merrill Lynch, iShares, Vanguard and State Street, which we believe to be reliable, but PFG cannot be held responsible for the accuracy of data used herein. Any use of graphs, text or other material from this report by the recipient must acknowledge MarketDesk Research as the source. Past performance does not guarantee or indicate future results.   Investing   involves   risk,   including   the possible loss of principal and fluctuation of value. PFG disclaims responsibility for updating information. In addition, PFG disclaims responsibility for third-party content, including information accessed through hyperlinks.

No mention of a particular security, index, derivative or other instrument in the report constitutes a recommendation to buy, sell, or hold that or any other security, nor does it constitute an opinion on the suitability of any security, index, or derivative. The report is strictly an information publication and has been prepared without regard to the particular investments and circumstances of the recipient.

READERS   SHOULD   VERIFY   ALL   CLAIMS   AND   COMPLETE    THEIR    OWN RESEARCH AND CONSULT A REGISTERED FINANCIAL PROFESSIONAL BEFORE INVESTING IN ANY INVESTMENTS MENTIONED IN THE PUBLICATION. INVESTING IN SECURITIES AND DERIVATIVES IS SPECULATIVE AND CARRIES A HIGH DEGREE OF RISK, AND READERS MAY LOSE MONEY TRADING AND INVESTING IN SUCH INVESTMENTS.

PFG Private Wealth Management, LLC is a registered investment advisor.

4Q 2022 Recap & 1Q 2023 Outlook

Recapping A Challenging 2022

Markets faced several challenges in 2022, including high inflation, historic central bank policy, the war in Ukraine, and Covid lockdowns in China. Inflation was a major factor in the markets throughout the year, with the headline consumer price index reaching a 40-year high of 9.1% in June. High inflation prompted the Federal Reserve and its global central bank peers to aggressively raise interest rates, which caused stocks and bonds to trade lower. There was no place to hide as central banks rapidly tightened monetary policy. Figure 1 shows the S&P 500 returned -19.4% in 2022, its worst annual return since 2008, and Figure 5 shows the Bloomberg U.S. Bond Aggregate produced its worst total return since 1976. This letter reviews the fourth quarter, recaps a difficult 2022, and discusses what the market will be focused on in 2023.

Putting 2022’s Interest Rate Hikes Into Perspective

The main story of 2022 was the reversal of monetary policy from extraordinarily accommodative levels during the Covid-19 pandemic. Figure 2 shows the speed and size of interest rate increases as central banks worked to bring inflation under control. The chart tracks the cumulative percentage of interest rate increases and decreases by global central banks during rolling three-month periods since 1995. For example, the 68% at the end of November 2022 indicates that central banks across the globe raised interest rates by a total of 68% from September to November. In contrast, the total amount of interest rate cuts during that same period was only 4%. As the data shows, 2022 was the quickest, largest, and most imbalanced global tightening cycle since the late 1990s.

The pace of interest rate increases is forecasted to slow during 2023. Central banks continue to hint that they are approaching the end of their interest rate hike cycle, citing concerns that further tightening could push the economy into recession. In addition, data suggests price pressures are easing. While the year-over-year headline consumer price index rose by 7.1% in November 2022, which is still high compared to historical levels, it was down from the 9.1% rate seen in June 2022. As inflation and central bank policy return to normal, a new uncertainty is emerging – the unknown effects of 2022’s rate hikes.

Markets Wait for the Lagged Effect of Higher Interest Rates to Show Up in Economic Data

The Federal Reserve’s interest rate hikes occurred in 2022, but the full impact of its restrictive measures has not yet been fully felt in the real economy. While the U.S. economy contracted during the first half of 2022, it expanded at a robust +3.2% annualized pace during the third quarter. Consumer spending remained strong throughout most of 2022 despite high inflation, and the U.S. labor market added more than 4 million jobs through the end of November. The data indicates the U.S. economy has withstood tightening thus far, but the real test will come in 2023 as the cumulative impact of higher interest rates becomes clearer.

While a recession is not a foregone conclusion, it is possible the economy could be tested in 2023. An index of leading economic indicators shows the U.S. economy is already starting to slow as the impact of higher interest rates takes hold. Figure 3 graphs the month-over-month change in The Conference Board’s Leading Economic Index, which tracks ten economic components that tend to precede changes in the overall economy. Included in the components are the average weekly hours worked by manufacturing workers, new home building permits, and the volume of new orders for capital goods, such as equipment, vehicles, and machinery. The chart reveals that the Leading Economic Index has decreased every month since March 2022, an indication the economy is slowing after a period of strong growth during the pandemic recovery.

Equity Valuations Are More Attractive, But Corporate Earnings Are An Open Question

Whereas inflation and central bank policy were the primary drivers of markets in 2022, economic data and corporate fundamentals are expected to play a larger role in determining the market’s direction in 2023. Figure 4 tracks two important S&P 500 metrics. The top chart tracks the next 12-month price-to-earnings ratio, which divides the S&P 500’s projected next 12-month earnings by its current price. It shows valuation multiples expanded during the pandemic as interest rates were cut to near 0% before reversing lower during 2022 as rising interest rates weighed on company valuations.

While current valuations are at a more attractive starting point today than at the beginning of 2022, corporate earnings are an open question entering 2023 with the potential for an earnings reset as the economy slows. The bottom chart in Figure 4 tracks the S&P 500’s trailing 12-month earnings growth, showing the jump in corporate earnings during the pandemic. Despite expectations for an economic slowdown, Wall Street analysts still forecast single-digit earnings growth for the S&P 500 in 2023. The positive earnings growth forecast is encouraging, but it creates a risk for the market. If actual earnings growth falls short of the forecast, stock prices could decline as markets price in lower actual earnings.

Equity Market Recap – Stocks Trade Higher in 4Q’22

Stocks traded lower during December but still ended the fourth quarter higher. The S&P 500 Index of large cap stocks returned +7.6% during the fourth quarter, outperforming the Russell 2000 Index’s +6.2% return. The Dow Jones Index, which includes large companies such as Visa, Caterpillar, Nike, and Boeing, was the top performer, returning +15.9%, while the Nasdaq 100 Index of technology and other growth-style stocks produced a -0.1% return during the fourth quarter.

Energy was the top performing S&P 500 sector during the fourth quarter, followed by the cyclical sector trio of Industrials, Materials, and Financials. Defensive sectors, including Health Care, Consumer Staples, and Utilities, were middle of the pack performers. Growth-style sectors, including Technology, Communication Services, and Consumer Discretionary, and interest-rate sensitive Real Estate underperformed as higher interest rates continued to weigh on valuation multiples.

International stocks outperformed U.S. stocks during the fourth quarter. The MSCI EAFE Index of developed market stocks returned +17.7% during the fourth quarter, while the MSCI Emerging Market Index returned +10.3%. A weaker U.S. dollar boosted the returns of international stocks, with U.S. dollar weakness driven by a shrinking monetary policy gap as other central banks catch up with the Federal Reserve’s aggressive policy. Separately, China’s decision to relax its Covid-zero restrictions raised the prospect of stronger global growth as one of the world’s biggest economies reopens.

Bond Market Recap – The Great 2022 Yield Reset

The bond market experienced a significant resetting of interest rates during 2022, with yields steadily rising as the Federal Reserve pushed through large interest rate hikes. Despite posting positive returns during the fourth quarter, bonds produced significant losses during 2022 as central banks raised interest rates at a rapid pace. The top chart in Figure 5 shows the Bloomberg U.S. Bond Aggregate produced a -13% total return during 2022, its biggest negative total return since tracking began in 1976. The bottom two charts in Figure 5 examine the current state of the credit market after 2022’s rate hikes. The middle chart shows the 10-year Treasury yield sits at its highest level since 2007. Yields are now higher across most credit classes, and investors can earn a yield of around 4% to 5% on a portfolio of high-quality bonds, such as U.S. Treasury bonds and investment grade corporate bonds, without locking up capital for long periods of time. In the corporate credit market, the bottom chart shows the high-yield corporate bond spread, which is the extra yield investors demand to loan to lower quality borrowers, is in line with its median since 1999.

The starting point for bonds, both in terms of yield and credit spreads, is now more compelling than it has been in a long time. However, there is still the potential for continued volatility in the bond market. There is still significant uncertainty regarding how high the Fed will need to raise interest rates and how long it will need to keep interest rates at restrictive levels to bring inflation down to normal levels. There is a risk that inflation could remain above the Fed’s 2% target, leading to an extended tightening cycle. At the same time, the economy is likely to start feeling the effects of 2022’s rate hikes in 2023, which could make bonds more attractive. The crosscurrents of uncertain central bank policy and a volatile global economy could keep interest rate volatility elevated and test bond investors’ nerves again during 2023.

2023 Outlook – Turning the Page on 2022’s Historic Tightening Cycle

2023 brings the next phase of the tightening cycle where the lagged effects of tighter monetary policy will be felt. It has the potential to be a year of two halves. In the first half, the focus is likely to shift from the number of future interest rate hikes to how much those interest rate hikes will slow the economy. Some data, such as the housing market, indicate that tighter monetary policy is being transmitted into the economy at a rapid pace. Home sales are slowing, and homebuilder confidence weakened every month during 2022 and now sits at its lowest level since 2012. At the same time, consumers continue to spend, and employers continue to add jobs. There is still a wide range of possible outcomes, and the unique nature of the pandemic followed by rapid interest rate cuts and hikes makes the path forward less certain.

The second half has the potential to be different depending on how severe the slowdown is in early 2023. Markets are based on forward-looking decisions, and investors will be watching closely for signs that the economy has bottomed and is recovering. Plus, Figure 1 contains an encouraging historical trend. The chart shows there have only been two instances of consecutive negative S&P 500 return years since 1950, in 1973-1974 and 2000-2002. This does not necessarily mean the S&P 500 will produce a positive return in 2023 or trade higher in a straight line from here, because it may not. However, it does provide helpful historical context in a volatile environment.

Wishing you and your family happiness and health in the New Year! We look forward to serving you another year.

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