After a brutal 2022 across most asset classes, many investors probably felt “cursed,” and as we entered 2023, there was no shortage of doomsday scenarios being espoused. And yet, risk markets year-to-date have proven to be resilient despite a still hawkish Federal Reserve.

If you were to just read the headlines, you might be surprised to know that the S&P 500 is up around 6.5% year to date as of March 31, and the Barclay’s bond index is up around 3% so far in 2023. Even more surprising to many is the performance of European stocks which are up over 15% just this year, and up 12% over the last year compared to negative overall returns for all the major domestic benchmarks.

All this has left investors feeling pretty polarized between extreme fear for some and renewed bullish sentiment for others.

Our advice to most investors at this time is to embrace the opportunity to be a diversified investor that exists today where many bonds are once again of value and many alternative asset classes are trading with attractive yields. After a decade of S&P 500-centric returns, there are many other asset classes that should not only help you dampen volatility but actually have real return potential themselves.

With higher interest rates just settling in at elevated levels and beginning to really work through the economy, it would not surprise us to see volatility pick up over the next couple of quarters.

That isn’t to say one should abandon equities, but we maintain our conviction that value and dividend-oriented sectors are likely the best place to be, not only from a total return perspective, but also for their dollar-cost averaging capabilities until greater direction appears within the Fed’s future policy.

The battle between deteriorating economic conditions and the timing and scale of future monetary easing and/or rate cuts from the Fed will determine whether the bulls or bears “win” over the next few months.

As summarized by JPMorgan, “While the odds of a U.S. recession have increased … the risk outlook for markets is becoming more balanced. Monetary policy should pose less of a headwind for stocks going forward. Economic data is moving in the right direction and the slowdown in inflation, wages, and activity should become more pronounced in the coming months. Moreover, if the outlook worsens, the Fed could ease monetary policy, which could provide significant support to financial markets. 

Meanwhile, the investment landscape still presents opportunities. Bonds can provide portfolios with attractive income and some capital appreciation when the Fed eventually cuts rates. An emphasis on quality is important, but broadly speaking, equity markets tend to perform well in the 12 months following an end of a tightening cycle.”

Adding to the uncertainty within markets is last month’s banking concerns. Alpine Macro still feels that perhaps the greatest risk is coming from overactive governments themselves that upend banking norms and trigger a crisis.

In any case, virtually everyone sees greater government regulation over the next couple of years and further consolidation within the sector. While many people are trying to “trade” these fears, our best advice would be to refrain from trading risk assets based on what are still guesses about banking’s future and remain mindful of your cash levels.

Tom Essaye, president of Sevens Point Research, points out that between the Fed discount window and Bank Term Funding Program, both of which exist to help banks in need of cash, the Fed has had to lend $160 billion just since March 1. He continues, “As the old saying goes, ‘Put your money where your mouth is.’ So far, banks’ money, and their mouths, are telling us that the regional bank crisis is not over, and if anything, may be getting worse.”

Goldman Sachs’ recent take on the financial crisis is a bit more benign. The company points out that, “While recent stress in the financial sector has raised concerns regarding the monetary health of banks, relative to the global financial crisis, many banks today hold more cash, fewer risky real estate loans, and have lower loan to deposit ratios. In addition, Tier 1 capital ratios, representing the first line of capital available to absorb losses, are at multidecade highs, providing capital buffers for these banks.”

On the potentially bullish side is the 10-year Treasury having seemingly put in a top with the yield having declined below its 200-day moving average.

As Bespoke Investment Group notes, this has usually resulted in decent markets over the next year, if not right away. Historically, after such drops below the 200-day moving average, there were just two where forward returns over the next year were extremely weak—October 1973, and March 2000.

“One thing to note about the 1973 and 2000 periods, though, is that the S&P 500 was pretty much weak right out of the gate once those streaks came to an end,” according to Bespoke. “For now, the S&P 500 has been able to tread water. The longer that continues to be the case, the more comfortable investors will be thinking that a repeat of either of those two periods is less likely.”

In summary, bullish investors need to see or believe the following:

•A banking crisis will be avoided.

•Inflation will continue to slow.

•The Fed will cut interest rates by year-end.

•A hard landing/severe recession will be avoided.

Bearish investors will likely need to see some combination of the opposite of two or more of the above.

It’s a fair fight, which is why we feel many income assets are such a great option. Many of them can “win” in either case, maintaining or increasing in value as safe havens in a recessionary risk-off event or possibly rallying alongside stocks in the event the Fed does engage in monetary easing sooner than is currently expected.

Tim Mitrovich is the CEO of Ten Capital Wealth Advisors LLC, in Spokane. He can be reached at 509.325.2003.