High Level Commentary


Volatile Start to 2023:

Markets are volatile but mostly positive so far in 2023.  The government debt default was averted as expected, but fears remain related to a potential banking crisis, protracted inflation and ultimately a possible recession.  Large financial institutions are well capitalized and appear to have reasonable risk control management, but mid-sized banks are more problematic.  Silicon Valley Bank realized large losses when they were forced to sell underwater longer-term bond holdings to fund panicked investor withdrawals.  Signature Bank troubles relate to a concentration of commercial real estate and crypto exposure.  Credit Suisse has been a weak performer for years, and was not able to fund investor withdrawals.  At this point, the “banking crisis” appears manageable and does not look a systemic threat.  The Federal Reserve raised interest rates by 0.25% on May 3, to a range of 5.0% to 5.25%, a 16-year high.     

2022 Performance Was Ugly:

The U.S. stock market and the bond market were both down sharply in 2022, with all major asset categories down on a year-to-date basis.  The S&P 500 performance was down -18.1% 2022.  The Bloomberg Aggregate Bond Index fell -13.1%, the worst decline ever.  A diversified 60/40 equity/bond portfolio fell over -15%, the worst performance since 1937. 

Breaking Things:

The Federal Reserve was too slow in recognizing inflation, and is now playing catch up by ratcheting up interest rates much more quickly than past cycles.  The Fed currently sees the need to take strong medicine now, to avoid a lot more later and for much longer.  The costs of doing too little on inflation outweigh the cost of doing too much.  Because interest rates are being raised at an unprecedented rapid rate, no one knows for sure how much the economy will slow.  Although some market pundits talk of a soft landing or a mild recession, a longer and deeper recession is certainly possible.  Consequently, the market fears the fed is breaking the economy. 

Inverted Yield Curve

 The bond market has been in an inverted yield curve position since July 2022 as short-term Treasury interest rates moved above the longer-maturity U.S. 10-year Treasury Note interest rate.  This inversion of the maturity timeline resulted from the Federal Reserve pushing up short-term interest rates to control inflation while the broader bond market, fearing a recession, pulled down long-term interest rates.  (The yield curve typically has an upward slope with lower short-term rates than higher long rates as investors require a higher rate to compensate for the longer maturity commitment and unanticipated inflation.)  This inverted yield curve has remained inverted, and an inverted yield curve preceded the last seven recessions.  As a result, there is heightened concern about a looming recession. 

Inflation, the Fed and Potential Recession:

The Federal Reserve raised short interest rates to a range of 4.25-4.50% during 2022 and they raised rates 0.25% in February, 0.25% in March, and 0.25% again in May to a range of 5.0-5.25%.  The market now expects a pause in rate increases and the beginning of rate cuts later in 2023.  The market may be too optimistic, because the Fed is waiting for “a meaningful reduction in inflation.”  The Fed is also allowing a faster roll-off of their $9 Trillion holdings at the U.S. Treasury.  Taken together, these actions demonstrate a significant commitment to reducing inflation.  It is now obvious that the Fed was too slow in recognizing persistent inflationary pressures, and there is now a fear that “catch-up” rate increases will cause a recession.  A Wall Street Journal poll shows that 63% of economists expect a recession within the next 12 months.  Moreover, a Conference Board survey shows that more than 60% of corporate CEOs expect a recession in the next 12 to 18 months.

Employment Conundrum:

Although a number of economic recession indicators point to recession later in 2023, the employment situation remains positive.  Typically, the employment conditions deteriorate along with the decline in other economic statistics.  There can be a lag, however, between economic deterioration and rising unemployment so employment conditions may eventually fall as well.


The U.S. economy advanced 1.1% in 2023 Q1, helped by solid consumer spending, but was held back by weak investment.  Although GDP dropped -1.6% in 2022 Q1 and -0.6% in Q2, the economy rebounded 3.2% in Q3 and 2.6% in Q4.  The two consecutive negative quarters of GDP is often seen as a recession, but the National Bureau of Economic Research is widely regarded as the official arbiter of recessions, and they have not called the drop in the first half of 2022 a recession.  The NBER often waits a number of months before officially calling a recession.  The Federal Reserve GDP forecast for calendar year 2023 is currently at 0.5% and 1.6% for 2024. 

Crypto Collapse:

The crypto exchange FTX (previously one of the biggest crypto exchanges in the world) declared bankruptcy on November 11.  After revelations of risky, unethical business practices, there was a surge of customer withdrawals.  Meanwhile, FTX had loaned out customer funds and then didn’t have sufficient funds to cover the customer withdrawals.  Unfortunately, investors using the FTX exchange will face a challenging legal battle in getting their crypto deposits back because the bankruptcy process will likely treat their deposits as uncollateralized unsecured claims.  FTX had been trading far above any fundamental value, so the precipitous decline was no surprise.  Bitcoin, the largest blockchain-based digital asset traded on crypto exchanges, dropped from an all-time high of $68,991 a year ago to under $17,000 after the bankruptcy announcement.

Matt Damon, Steph Curry, Gisele Bündchen and others previously pitched cryptocurrency exchanges, and this bankruptcy debacle shows the importance of financial advice from experienced professionals rather than celebrities.  It is also ironic that the NBA’s Miami Heat are playing in the newly renamed FTX Arena.

The FTX bankruptcy does not appear to pose systemic risk to the traditional financial system, a so-called “Lehman” moment that helped precipitate the 2008 Great Financial Crisis.  This experience clearly highlights the value of established exchanges like the New York Stock Exchange and the regulatory infrastructure protecting

Russian invasion of Ukraine:

The immediate impact has been the loss of life and devastation of civilian targets.  In addition, energy and food prices rose sharply, curtailing economic growth, threatening regional food supplies and increasing recession risks.  After the initial energy price shock, oil and natural gas prices have moderated.  Russia ranks as the 11th largest country in the world, but Russia produces 10% of the world’s oil and over 25% of global palladium.  Russian accounts for nearly half of EU natural gas imports and almost a quarter of oil imports. 

Russia and Ukraine account for nearly 30% of global wheat exports, one-fifth of the corn trade and 80% of sunflower oil production according to the USDA.  Prices have skyrocketed and raised concerns about food security, especially in the Middle East and North Africa.

Geopolitical risks have been highlighted as the security structure in place since the end of WWII has unraveled.  Before the invasion of Ukraine, Putin sought closer relations with Xi Jinping, as was evidenced by their joint appearance at the Winter Olympics in Beijing.  China is concerning because it continues to see Taiwan is a breakaway region.  Finally, Iran continues their nuclear development capabilities.  The unified global response and sanctions against Putin and Russia, however, has cast a very negative image of military aggression by Russia, China or Iran.   

Short-Term Positive:

Household debt levels are in good shape. The household debt-service ratio is lower than at any time prior to the pandemic and cash represents about 25% of total household debt—the highest level since 1970.

U.S. corporate balance sheets are strong with U.S. corporate debt to after-tax profits as low today as it was in the 1960s.

Corporate earnings surprised to the upside during 2021 and 2022.  Despite recession fears, earnings according to FactSet are expected to increase 1.2% in 2023 and revenue growth is expected to increase 2.4%.  Current conditions are clearly being impacted by the economic slowdown and FactSet sees 23Q1 earnings down -2.2% before recovering later in 2023.  If inflation remains higher than expected, then broad-based consensus earnings growth could be revised downward. 

Geopolitical risks.  Although wars are tragic, history shows that the market generally has positive performance a year after hostilities begin.

Retail sales.  Retail sales advanced 0.4% in April, and are up over 2.6% year-over-year based on a strong labor market. 

The $430 billion Inflation Reduction Act-IRA (down from the original $3.5 trillion and then revised down to $2.2 trillion Build Back Better plan) passed in August along party lines.  The legislation covers climate change, health-care spending and tax increases over the next 10 years.  The legislation was described as reducing the budget deficit by $300 billion, but analysis by the Congressional Budget Office shows the package is expected to reduce the budget deficit by $102 billion.    

The $1 trillion infrastructure package was previously passed in November 2021 with bipartisan support, and economists believe that this spending has the potential to increase economic growth and productivity.  Growth and productivity gains will be modest, however, since the funds will be spent over a number of years. 

Some of the stimulus dollars moved into the markets.  This provided short-term investment demand to push prices higher.  Although there are no more stimulus payments, there continues to be significant retail “cash on the sidelines” that can help stabilize the market. 

Short-Term Negative:

The market faces strong headwinds as the Federal Reserve continues to push up interest rates to battle inflation.  There is a question with how far and how fast the Federal Reserve will push up interest rates.  The geopolitical developments related to Ukraine and Russia are obviously a continuing concern.  The Fed is in a difficult position as it seeks to balance the risk of higher rates on bank profitability and ongoing inflation.

The US Dollar was strong in the first half of 2022 but has softened since then.  This dollar weakening positively impacts domestic, foreign developed and emerging markets.  The softer dollar helps domestic companies with significant foreign sales.  Foreign purchases of oil and other imports are typically transacted in US dollars, and this helps their local economies. 

The Conference Board’s Leading Economic Indicators were down -0.6% in April due to weak consumer expectations, a residential housing slowdown and inflation fears.  The LEI is now down for the last 14 months, and indicates a looming recession. 

-Recession and Market Performance.  The S&P 500 dropped -39% from the January 3 2022 all-time-high to the October 2022 bear market low.  Performance has rebounded somewhat since October and was down -18% for the year, and volatility remains high.  There have been 17 bear markets since World War II and the average decline has been -31%.  Of the 17 bear markets, 9 were accompanied by a recession, and the average recessionary decline was -36%.  The market has been positive so far in 2023, but recession fears remain high

Consumer inflation remains a problem although recent data shows slightly lower growth rates.  The April headline Consumer Price Index was up 4.9% over the last twelve months.  The core CPI, net the volatile food and energy sectors, was up 5.5% year-over-year.  Although inflation is trending down, inflation remains at levels not seen since the early 1980s.  Federal Reserve officials previously said that inflation was “transitory” due to supply chain problems, but inflation has broadened into wages, and this raises the potential for a wage price spiral.  Rent is also rising at an uncomfortably high level over the last twelve months.  History shows that inflation is hard to contain after it has gained momentum.  The market is very concerned that inflation may last longer than current Fed public statements. 

The $1.9 trillion government stimulus package passed back in March 2021 helped economic growth exceed expectations in 2021, but it now appears that last year’s stimulus is fueling current inflation.  Forecasts for 2022 are now being revised downward on current inflation and recession fears.  Although calendar year 2022GDP growth is expected to remain positive, there is a greater likelihood of a recession developing later in 2022 or 2023. 

Geopolitical:  The Ukraine/Russia conflict is a clear negative development.  The market previously dismissed this risk, but the invasion forced up energy and other commodity prices, and the broader impact is clearly negative.

The so-called Fed Put gave investors a measure of downside support for the markets over the last decade.  (In the options market, a “Put” position increases in value when markets decline and thus provides an upside offset or hedge against market drops.)  Although there was no actual market “Put”, the Federal Reserve purchased massive quantities of bonds and kept interest rates abnormally low to support the economy and the markets.  Now that the economy is strong and inflation is uncomfortably high, the Fed no longer has the latitude to keep interest rates low to support the market.  Instead, there is a need to raise interest rates to mitigate against inflation.  As interest rates rise, consumer and corporate spending growth rates decrease, the economy slows, and long-maturity bonds and stock market performance face increasing headwinds.

The Federal Reserve’s monetary stimulus kept interest rates low but it had the effect of distorting markets by shifting investors towards risky assets.  As stimulus has phased out, markets have moved down.  Monetary and fiscal stimulus have been at unprecedented levels and more volatility and negative performance is certainly possible.

Asset price inflation for both stocks and bonds pushed market prices well above average fundamental valuation levels by year-end 2021.  Valuation levels moderated in 2022 but are still relatively expensive in 2023 for long-maturity bonds and U.S. large cap stocks.

Investors took out record volumes of margin debt to finance their stock purchases.  Buying stocks on margin is extremely lucrative as long as stocks continue to move up, but a market downdraft causes heavy selling to meet margin calls.  Option volumes are also at record high levels according to the Options Clearing Corporation.  Purchasing Options in a rising market allows much larger gains than buying stocks, but losses are amplified in a sharp sell-off.  Market makers who sell options to investors typically hedge their position by purchasing the underlying stock.  When markets decline and option purchases decline, market makers sell their stock holdings.  Margin debt and option purchases provide upward momentum, but these trading tactics also cause severe negative volatility.      

Evergrande is a Chinese property developer that defaulted on bond payments in its $300 billion debt holdings.  Other Chinese property developers are also experiencing cash flow problems, and the property sector is a clear drag on the Chinese economy.  The market fears “contagion” that spreads throughout the Chinese economy and into international markets. 

Longer-Term Fundamentals:

Federal Reserve “Tapering” Increased Interest Rates and Negative Performance:

The Federal Reserve’s belated recognition of inflation risks and its policy shift has spooked markets and caused negative returns for most asset classes in 2022.  The shift to higher interest rates is described as the end of easy money, and the narrative is now characterized as how high and how fast. 

The policy shift was publicized by the Fed on December 15, 2021 with commentary that they are ending their bond purchases and introducing a policy to raise short-term interest rates to combat inflation.  The government bond purchases began at the height of the pandemic to help support the economy and markets when businesses were closed and unemployment skyrocketed.  The government bond buying helped reduce interest rates.  (Interest rates on existing bonds declined because Fed purchases drove up bond prices and correspondingly reduced interest rates.)  Starting in March 2022, the Fed pushed up interest rates at the fastest pace in the last 40 years.  As of May 2023, the Fed Fund Rate has been pushed up to a range of 5.0% to 5.25%.  Since rate increases impact the economy with a “long and variable lag”, neither the Fed nor anyone else can know exactly how much the economy will slow and inflation will decline.  At this point, the economy has shown reasonable resilience.  

 U.S. Economic Statistics are weakening as inflation concerns increase.  Economic statistics dropped precipitously due to the government-induced shutdown in early 2020, but then rebounded well above consensus expectations.  Most recently, economic reports are showing an increased likelihood of a recession. 

-Retail sales have been stronger than expected over the last year despite rising gasoline and food prices.  Fiscal stimulus has ended but U.S. households accumulated over $2.5 trillion in excess savings during the pandemic, and this should drive strong consumer spending throughout 2023. 

-Unemployment (at a 50-year low of 3.5% in February 2020) spiked to 14.7% as the pandemic shut down the U.S. economy, but now stands at 3.7% for May 2023.  Job creation for May came in at a solid 339,000 new jobs.  The overall employment trend remains positive as companies scramble to find workers to meet strong demand.  

-Industrial production was up 0.5% in May and it is up 1.0% over the last year. 

-Housing had been strong due to low mortgage rates, but new construction is currently negatively impacted by rising mortgage rates and rising construction costs.  These rising costs impact housing affordability, especially at the lower price points for younger families.

-Inflation has been low over the past decade, but is currently at historically high levels.  The overall April Core Consumer Price Index came in at a trailing 12-month 5.5%. 

-The Eurozone grew at a 0.3% rate for the first quarter of 2023.  The EU experienced slower economic growth due to the war in Ukraine and inflation, but the region is demonstrating experiencing economic recovery. 

-China reported 2023 Q1 4.5% GDP growth, showing that their economy is recovering from previous COVID containment issues and supply-chain problems.  This growth is a positive factor for overall global growth.

Performance:  U.S. stock indexes moved up to record-high levels based on government stimulus and optimism with COVID-19 vaccine in 2021, but performance in 2022 was negative.   Energy, industrials, financials and small cap stocks performed better as the market rotated away from some of the tech darlings.  After the huge 2022 sell-off, stocks are positive again in 2023.  Small cap stocks are cheaper and have more earnings upside as the economy recovers from inflation. 

Longer maturity bonds underperformed in 2022 as interest rates rose, but are performing better in 2023.  While fiscal stimulus was necessary due to COVID restrictions and lockdowns, there is a growing concern related to persistent inflation and to huge government budget deficits.  Investors are less willing to accept historically low longer-term government debt, and this is pressuring long-maturity bond prices lower as yields move higher.

Climate change constitutes a significant longer-term global challenge.  Although governments and corporations are taking steps to mitigate the impact, recent increased energy costs have caused a consumer backlash.  It is much easier to talk about reductions far out in the future, than it is to implement current steps to make actual changes.

Market valuations are down but are not cheap.  At this point, markets are trading on recession fears and the prospect of weaker corporate earnings growth.  Various valuation metrics (like Price/Earnings ratios) are down, but could decline further if earnings growth is negatively impacted by inflation.  It is important to remember that valuation doesn’t predict short-term performance, but valuation definitely impacts long-term performance potential.  In other words, markets could move up or down on a short-term basis, but the longer-term performance might be a 5% average long-term return/year rather than the historic 10%/year return.

Stimulus packages helped in the short run, but debt keeps growing.  Three stimulus bills have been enacted since the beginning of the pandemic in March 2020.  These bills are summarized below: 

-The $2.2 trillion CARES Act, passed quickly in March 2020, provided $1,200 direct payments and enhanced unemployment benefits.  

-The $900 billion Pandemic Relief Bill passed in December 2020.  This provided $600 in direct payments to eligible individuals and $300/week in extended unemployment benefits through March 2021.

-The $1.9 trillion American Rescue Plan passed in March 2021.  This plan included $1,400 direct payments to most Americans and extended additional unemployment benefits through the summer. 

The U.S. federal debt stands at over $31 trillion, and is expected to continue to grow for the foreseeable future.  Although current interest rates remain low, future inflation could cause rates to rise, and this would cause sharply higher debt service costs.  This is clearly a headwind on a longer-term basis.


For more detail see:

Markets & Economics

Market Performance


Cornerstone maintains significantly more data and graphs than what is presented in this website.  Contact Jeff Johnson regarding specific data questions and comments.

Yahoo Finance link is helpful for daily market activity:  http://finance.yahoo.com/