IMG Q1 2023 Investor Letter

Welcome Spring!

The change of seasons brings with it the promise of longer days, new beginnings and growth. However, it is a long, gradual transition that has some drawbacks…think allergies and temperamental weather, to name a couple. Same with the markets; economic growth and higher returns endure challenges. That was certainly the case during the first quarter of the year as we faced persistent high inflation, a banking crisis, and continued uncertainty regarding the future of the markets. Despite this backdrop, the S&P 500 gained 7.5% since the start of the year, and the technology-heavy NASDAQ rallied 17.1%. Challenges and/or setbacks are inevitable. We have purposefully constructed our client portfolios to minimize downside risk through proper diversification and believe there are appropriate protection measures in place to withstand the unpredictable.

US Economy

The U.S. economy started 2023 on relatively strong footing. Inflation cooled on a relative basis for the sixth successive month in December, fourth quarter Gross Domestic Product (GDP) growth came in stronger than expected, and industrial activity improved in January. The market remained hyper focused on inflation data as a predictor of future Federal Reserve (Fed) rate adjustments, and given the continued declines in Consumer Price Index (CPI) numbers, the market quickly priced in the possibility of a slower pace of rate hikes. This resulted in increased risk appetite for both stocks and bonds, with many of the worst performing stocks of 2022 materially outperforming the S&P 500 in the first quarter of 2023.

The Fed’s preferred measure of inflation, the core Personal Consumption Expenditures price index (PCE), stopped falling in January, coming in at 4.7%, higher than the 4.3% economists had expected. Given the backdrop of stronger than expected economic data, a modest move upward in inflation, and a tight labor market, participants began to worry that the central bank may have to be more aggressive than expected on monetary policy. At the Federal Open Market Committee (FOMC) meeting in early February, the Fed boosted the federal funds rate by 0.25%. While this was a welcome reduction in the monthly pace of increases, the Fed reiterated that ongoing rate increases may be appropriate to bring inflation under control.

However, the series of bank collapses in March, first Silvergate Bank, then Silicon Valley Bank, and finally Signature Bank, challenged Fed policy as it underscored the downside of rising rates and interest rate risk. These events sparked concerns about the health of the banking system and whether or not the bank failures could lead to broader negative economic implications. Conventional Wall Street wisdom suggests that when the Federal Reserve begins to raise interest rates, they will continue on that path until something cracks. The Fed now needed to weigh the likely tighter lending conditions and shrinking liquidity associated with the banking system turmoil alongside the continued need to combat high inflation. The job is not done yet. Federal Reserve Chair Jerome Powell has indicated that there are costs associated with bringing down inflation, but the costs of allowing inflation to remain above the Fed’s 2% target level would likely have worse implications. To that end, the Fed raised the target rate by another 0.25% in late March.

Looking at other economic data, the most recent U.S. unemployment report was mixed, showing strong payroll gains and increased labor force participation, but a higher unemployment rate. Simply put, this indicates people are re-entering the workforce, looking for work, but not always finding it. Slower average hourly earnings growth indicated that the labor market is cooling off a bit, but most of the easing in wage growth was driven by layoffs in higher paying industries. Despite the technology sector experiencing some of the largest layoffs, as companies who over hired during easier monetary conditions are rightsizing their workforce, overall wage growth remains strong.

The latest Consumer Price Index (CPI) data was also mixed. Prices eased in February from January, but core inflation, which excludes volatile food and energy prices, still remains above where the Fed would like to see it. However, there has also been some weakness in retail sales numbers and lower-than-expected Producer Price Index (PPI) data. Lower producer prices likely mean consumers will pay less at the retail level, which would support a potential pause in the Fed’s rate-hike cycle.

Rising inflation in 2022 forced the Fed to increase the target rate at the fastest pace in 40 years, and the effects are still rippling through the economy. While we cannot predict what the Federal Reserve will do, we expect that the recent banking system issues will continue to be on the mind of the Fed as they consider the right path going forward.

US Stock Market Recap

We witnessed a stock market rally to start the year, driven by the rationale that the Fed was closer to a target terminal rate and that company profit estimate declines had moderated materially. The result was the S&P 500 climbing 6.28% to start January, with an even sharper rise in the tech-heavy NASDAQ composite. However, this optimism quickly faded as signs that rate hikes were having an economic impact began to emerge. The S&P 500 pulled back in February, but managed to remain positive in March despite turmoil in the banking sector. The S&P 500 finished up 7.50% in the first quarter, even with a challenging macroeconomic backdrop. Despite volatility in the quarter, the market seems to be looking past near-term challenges, encouraged that the banking crisis was managed without broader economic implications and that the Federal Reserve may be close to reaching the terminal rate for interest rates.

Seven out of 11 GICS sectors posted positive returns in the quarter. Technology (+21.82%) was the standout sector, followed by Communications (+20.50%) and Consumer Discretionary (+16.13%). The Real Estate sector fell sharply in February and March in response to banking system unrest and rising concerns around Commercial Real Estate (particularly office space), but still remained slightly positive for the quarter. Energy was among the worst performing sectors in the quarter, down 4.67%. Not surprisingly, the Financials sector was the worst performing sector, down 5.56%, as upheaval in the regional banking sector caused broader fear and contagion.

From a style standpoint, growth outperformed value, with the Russell 1000 Growth index up 14.37% and the Russell 1000 Value index up 1.01%. Growth companies are generally expected to grow their sales and cash flows at a faster pace than the overall market. They can be young, unproven, volatile firms in innovative fields, many of which pay little to no dividend. Moreover, they are generally more sensitive to moves in interest rates as their future cash flows may be less certain and further out into the future. The rate on the 10-year Treasury note peaked in the fourth quarter of last year to 4.25%, but has since fallen to roughly 3.5%, which provided a nice tailwind for Growth stocks.

Another trend was the flight to quality; the S&P 500 Quality Index (+8.11%) significantly outperformed as investors flocked to safe-havens amidst the market volatility. Similarly, Large/Mid Cap outperformed Small Cap, with the Russell 1000 up 7.46% and the Russell 2000 up 2.74% in the quarter.

Fixed Income

Fixed income investors found themselves riding a proverbial roller coaster throughout the first quarter of 2023 with interest rates moving sharply in both directions. Market participants fueled yield curve gyrations as they continuously attempted to predict monetary policy by interpreting Federal Reserve commentary, meeting minutes, economic data releases, and news headlines.

To begin the year, we saw reports indicating slower growth which gave optimism the Fed could pause their rate increases. This momentum soon gave way to a stark reversal in February where strong sales and jobs reports led many to believe the Fed would be forced to continue with rate hikes. In March, the bond market quickly reacted to the news of the Silicon Valley Bank demise and concerns for a deeper more widespread banking crisis. There was an immediate credit impact that caused rates to decline in a flight to quality. The Fed, FDIC, and the U.S. Treasury together acted swiftly to secure all depositors of failing banks. The Federal Reserve Board also announced the creation of the Bank Term Funding Program (BTFP) to help ensure banks could meet the needs of all of their depositors in the future. These actions reassured markets that the banking system was healthy and strong. The Fed then stated additional hikes were warranted to continue fighting persistent inflation by deciding to raise rates an additional 0.25% in late March, as they had in their prior meeting in February.

Q1 Yield Curve 2 Year 5 Year 10 Year 20 Year
03/31/2023 4.03% 3.57% 3.47% 3.80%
02/28/2023 4.82% 4.18% 3.92% 4.11%
01/31/2023 4.20% 3.62% 3.51% 3.77%
12/31/2022 4.43% 4.00% 3.88% 4.14%

Despite the back and forth, the bond market ended the quarter with strong positive returns across all sectors after an historically difficult 2022. Longer term bonds were among the best performers, in addition to High Yield and Convertible Bonds which have higher correlations to the stock market.

As we look toward the May and June Federal Reserve meetings, fixed income investors are also closely watching the U.S. Congress and the need to raise the debt ceiling. Our disciplined process has us well positioned to protect against any upcoming uncertainty in 2023, and we continue to welcome these higher yields as an opportunity to earn additional income.

Diversifying Asset Class Performance

Diversifying equity asset classes did not add much value in the first quarter. Many U.S. diversifying asset classes, including REITs, Mid Cap, Managed Futures, and MLPs, underperformed the S&P 500 in the quarter.

Conversely, diversifying fixed income asset classes added significant value in the first quarter. Foreign bonds, Inflation-Protected bonds, High Yield Bonds, Bank Loans, and Convertible bonds all outperformed the Bloomberg U.S. Government/Credit Intermediate index in the quarter.


While 2022 suffered declines in both U.S. Equity and Fixed Income markets, the first quarter of 2023 saw renewed strength and positive returns. The collaboration of The Federal Reserve, FDIC, and the U.S. Treasury to provide stability and calm the banking turmoil helped restore confidence in the markets. Still, uncertainty around the Fed’s future path as well as the looming debt ceiling debate may continue to cause volatility in the markets. We plan to help you meet your long-term financial goals in all environments and encourage you to stay the course.

As always, should you find yourself questioning your current situation, our team is always here to help you weather these challenging times. Thank you.



David B. Smith, CFA

Managing Director and Chief Investment Officer

Not Insured by FDIC or Any Other Government Agency / Not Rockland Trust Guaranteed / Not Rockland Trust Deposits or Obligations / May Lose Value