Yields and cautious positioning helping equities
The first quarter of 2023 has been quite a turn from last year. The S&P 500 ended 2022 down close to 20% but is up 3% YTD while the NASDAQ100 ended 2022 with declines of over 30% but is now up 17% YTD. This may be unexpected as the macro situation looks far more vulnerable, with 2022 seeing inflation risks remaining top of mind, but the banking sector troubles have added to that recently and raised the risks of a credit crunch leading into a recession.
Part of the reason for the sustained stability in equities has been the slide in Treasury yields as Fed rate hike bets have been pared quickly. But this is potentially a sign of short-sightedness, where investors are focused on a dovish turn in Fed policy but still not ready to price in the threat of a recession that could take the equity risk premiums higher even as lower interest rates help to improve the valuations.
Another key reason has been positioning, where many investors had scaled back their exposures last year and in the run upto the collapse of SVB earlier in March. This lowered the rate of exodus from the markets as the new crisis hit. Meanwhile, sentiment has been supported so far with the regulators announcing quick measures even as uncertainties linger and risks of further fallouts in the financial sector remain.
Tech outperformance vs. small caps
A more micro trend evident YTD has been the outperformance of the large growth stocks, and that is also what is driving key indices higher YTD. Market breadth is reducing as large-cap stocks outperform and drive broader indices higher, but beneath the surface, a larger number of mid-to-small cap stocks continue to decline. Apple and Microsoft have climbed 23% and 17% respectively YTD. Google parent Alphabet is up 20% as well, while Meta is up 71% after a decline of 64% in 2022.
The reason for tech outperformance once again partially comes from lower yields, as these companies are usually more interest rate sensitive and scaling back of Fed rate hike bets has been boon to the high-growth tech sector. The companies have also been leading cost management, with massive layoffs being announced since late last year, and may be able to deliver better-than-expected earnings for the first quarter.