Thrivent Asset Management Contributors to this report: Steve Lowe, CFA, Chief Investment Strategist; John Groton, Jr., CFA, Director of Administration and Materials & Energy Research; Matthew Finn, CFA, Head of Equity Mutual Funds; and Jeff Branstad, CFA, Model Portfolio Manager

The tech-heavy NASDAQ Index surged nearly 17% in the 1^st quarter, rebounding from a 33.10% decline in 2022. The S&P 500^® was also in positive territory, with a total return (including dividends) of 7.50% for the quarter.

After a steep 28.19% drop in 2022, the Information Technology sector of the S&P 500 was up 21.82% in the 1^st quarter, as investors migrated to stocks they believed could best weather ongoing inflationary pressures. Communication Services, which tumbled 39.89% last year, jumped 20.50% in the 1^st quarter this year.

Meanwhile, the inflation-fighting monetary policy of the Federal Reserve (Fed) churned up problems in the banking industry. A few regional banks faced heavy losses in their fixed income holdings and were forced to seek rescue financing or closure. The first to be shut down was Silicon Valley Bank in California, which ceased operations on March 10, followed by Signature Bank in New York two days later. The biggest domino to fall was Credit Suisse, Switzerland’s second largest lender, which was acquired by UBS Group March 19 after facing billions of dollars in losses.

The banking crisis was triggered by realized and unrealized losses on fixed income holdings at the troubled banks. Their problems were caused by the rapid increase in interest rates by the Fed, along with what appears to be poor risk management by the banks. As interest rates rose, the banks’ existing lower-interest bonds and mortgage-backed security holdings continued to decline in market value.

Despite the banking dust-up, the Fed still raised rates an additional 0.25% in March, bringing to 5.0% the total increase since the Fed began raising rates early last year.

Sticker shock

The Fed’s efforts have had some effect at slowing inflation – energy prices have dropped, corporate earnings growth has slipped, and manufacturing activity has declined – but consumers are still facing sticker shock.

The Consumer Price Index (CPI), a common gauge of inflation, was up 0.4% in February and 6.0% over the previous 12 months, according to the March 14 Bureau of Labor Statistics report. Excluding food and energy, the index was up 5.5% over a year earlier, the smallest 12-month increase since December 2021.

Consumers are paying 14.6% more now for transportation services than they were a year ago, through February, while energy services are up 13.3%. Whether you dine out or eat in, you’re now shelling out a lot more than a year ago. Food at home is up 9.5%, while food away from home is up 10.2%. However, commodities not including food and energy are up only 1.0% from a year earlier.

The cost of used cars, after spiking after the pandemic shutdown, has dropped 13.6% since a year ago. Apparel is up 3.3%, medical care is up just 2.1%, and shelter – which is affected by higher mortgage rates – is up 8.1%.

The rising prices may be affecting consumer spending. While personal income was up 0.3% in February and disposable personal income was up 0.5%, consumer spending tapered off. Personal consumption expenditures (PCE) were up just 0.2% in February after a 2.0% rise in January, according to a March 31 Bureau of Economic Analysis report.

Employment has remained strong with job growth reaching 27 consecutive months in March, according to the Department of Labor. With more than 10 million job openings in the U.S., employment may continue to tick up in future months.

The manufacturing sector has been affected by the Fed’s tightening efforts.  Manufacturing activity declined in March for the fifth straight month after 30 consecutive months of growth, according to the Institute for Supply Management (ISM) report issued April 3. Only six of the 18 industries tracked by ISM reported growth in manufacturing activity in March, while the other 12 reported a decline.

Drilling down

U.S. stocks rebound

After dropping nearly 20% in 2022, the S&P 500^® Index was up 7.03% in the 1^st quarter of 2023, from 3,839.50 at the end of 2022 to 4,109.31 at the March close. The total return of the S&P 500 (including dividends) was 7.50%. (The S&P 500 is a market-cap-weighted index that represents the average performance of a group of 500 large capitalization stocks.)

The NASDAQ Index was up 16.77% in the 1^st quarter, from 10,466.48 at the close of 2022 to 12,221.91 at the end of March. (The NASDAQ – National Association of Securities Dealers Automated Quotations – is an electronic stock exchange with more than 3,300 company listings.)

Retail sales slip

Retail sales were down 0.4% from the previous month in February as the Fed rate hikes hammered the economy. But sales were 5.4% above February 2022 sales, according to the Department of Commerce retail report issued March 15. For the three-month period from December through February, sales were 6.4% higher than the same period a year earlier.

Building material sales were down 0.1% from the previous month in February, while department store sales were down 4.0% for the month but up 2.5% from a year earlier. Auto sales were down 2.0% from the previous month and down 0.8% from a year earlier.

Non-store retailers (primarily online) were up 1.6% from the previous month, and up 8.5% from a year earlier. With consumers returning to restaurants and bars, sales at food services and drinking establishments were up 15.3% from a year ago. But they dropped 2.2% from the previous month amid rising prices.

Job gains continue

The economy added 236,000 new jobs in March, according to the Employment Situation Report issued April 7 by the Department of Labor. It was the 27^th consecutive month of job growth in the U.S.

The unemployment rate remained at just 3.5% in March. Most growth occurred in the food services and drinking places sector, government services, professional and business services, and healthcare.

Average earnings increased by 0.3% in March, with hourly earnings rising by $0.09 for the month to $33.18. Over the past 12 months, hourly wages have increased by 4.2%.

Tech area leads 1^st quarter rebound

The two leading sectors of the S&P 500 in the 1^st quarter were Information Technology, up 21.82% for the quarter, and Communications Services, up 20.50%. Other leading sectors included Consumer Discretionary, up 16.13%, and Materials, up 4.29%. Rocked by the banking crisis, the Financials sector was down 9.55% in March and 5.56% in the 1^st quarter. 

The chart below shows the results of the 11 sectors for the past month and 1^st quarter:

Treasury yields ebb

After rising to nearly 4.0% in February in response to Fed rate hikes, the yield on 10-year U.S. Treasuries dropped back down to 3.49% to close the 1^st quarter. The drop in bond yields has been attributed to expectations that the Fed is nearing the end of its rate hike policy.

As interest rates sank, the Bloomberg Aggregate Bond Index, which tracks the performance of U.S. investment-grade bonds, was up 2.96% in the 1^st quarter, including 2.08% in March.

Corporate earnings slip

Corporate 12-month earnings projections for the S&P 500 declined 0.99% in the 1^st quarter, as the monetary tightening polices of the Fed continued to be a drag on the economy. However, projected earnings did edge up 0.44% in March.

Forward P/E ratio edges up

The forward 12-month price-earnings ratio (P/E) of the S&P 500 moved up in the 1^st quarter after declining throughout much of 2022. The P/E ended the quarter at 18.07, up from 16.65 at the close of 2022. A higher P/E means stocks are more expensive relative to their earnings per share. The 18.07 P/E was still below the 20.96 P/E at the end of 2021.

The forward 12-month earnings yield for the S&P 500, which is the inverse of the P/E, ended the 1^st quarter at 5.55%. That was below the 6.01% at the end of 2022. The 12-month forward earnings yield can be helpful in comparing equity earnings yields with current bond yields. The 5.55% equity earnings yield is still well above the 3.49% market rate of 10-year U.S. Treasuries.

Dollar drops vs. Euro, gains vs. Yen

After reaching a 20-year high versus the Euro and Yen, the dollar declined versus the Euro over each of the past two quarters. The Euro appreciated 1.80% versus the dollar during the 1^st quarter of 2023 after rising 8.94% versus the dollar in the 4^th quarter of 2022.

The dollar increased slightly versus the Yen in the 1^st quarter, gaining 0.87% versus the Japanese currency. That followed a drop of 8.84% against the Yen in the 4^th quarter. Through all of 2022, the dollar had gained 14.58% versus the Yen. The increase in the relative value of the dollar has been attributed to the Fed’s intensive monetary tightening policy versus a relatively loose monetary policy by the Bank of Japan.

Oil prices stall while gasoline prices jump

Oil prices dropped slightly in the 1^st quarter, as demand declined due to the slowing global economy. The price of West Texas Intermediate, a grade of crude oil used as a benchmark in oil pricing, dipped 5.72% for the quarter, from $80.26 at the close of 2022 to $75.67 at the end of March.

However, OPEC+, which is a consortium of oil producing nations, announced plans in early April to cut oil production by more than 1.6 million barrels a day starting in May. Shortly after the announcement, oil prices rebounded back up to about $80 a barrel.

Gasoline prices at the pump surged in the 1^st quarter. The average price per gallon climbed 10.30%, from $3.20 per gallon at the end of 2022 to $3.53 at the March close.

Gold prices rise

After a slump in gold through much of 2022, the price has risen significantly over the past two quarters in response to persistent inflation. Gold prices rose 9.22% in the 4^th quarter of 2022, followed by an 8.76% increase in the 1^st quarter of 2023. After ending 2022 at $1,826.20 per ounce, gold prices broke over $2,000, ending the 1^st quarter at $2,001.40.

International equities move higher

International equities continued a positive trend in the 1^st quarter of 2023 after finishing 2022 with a strong 4^th quarter. The MSCI EAFE Index was up 7.65% in the 1^st quarter after surging 17.00% in the 4^th quarter of 2022. The index, which tracks developed-economy stocks in Europe, Asia, and Australia, rose from 1,943.93 at the end of 2022 to 2,092.60 at the close of the 1^st quarter.

What can you expect from the economy and the markets in the months ahead? See: The Thrivent 2nd Quarter 2023 Outlook, by Chief Investment Strategist Steve Lowe.