Despite barely avoiding a banking catastrophe, the first quarter of 2023 ended with the S&P 500 index up 7.03% (and up 3.51% for the month of March). Apart from the S&P’s impressive start to the year, the Nasdaq Composite (technology companies) shined brightest with its strongest quarterly gain (+17.05%) since the second quarter of 2020.
In fact, much of the recent optimism in the markets has been driven solely by the strength in Technology sector; an historical outperformer but was left for dead in 2022 as investors rotated to stocks that paid dividends and were undervalued.
However, not everyone is believer at this point in the cycle. Skeptics are dismissing these gains as mere “noise” and believe a bear market will reappear at some point this year.
So, are first quarter gains a sign of what’s to come or are we about to step into a bear trap?
The key to determining this answer will be (and has been for a while) whether inflation is falling faster than expected.
If inflation remains persistent, the Federal Reserve is not going to stop raising interest rates until “something breaks”. Last month’s week-long banking crisis was an example of something breaking. Thankfully, the Biden administration acted swiftly with the help of the FDIC by shoring up large deposit and easing panic across the regional bank landscape. Eventually though, if rates keep going up to combat inflation, something will break that can’t be fixed overnight.
On the other hand, if inflation is falling faster than expected (which is my prediction), than the 1st quarter gains of 2023 look like a preview for what in store for the rest of the year as the doubters/bears will be trapped on the sidelines and the historically high level of cash will start to re-enter the market, continuing to fuel the rally.