The Banking Crisis Dominated the News, But Financial Markets Delivered Strong Returns in the First Quarter

The first quarter was positive across nearly all asset classes and strategies, notwithstanding considerable turbulence around the worst banking crisis in over a decade. Stocks started the year strongly, but the rally reversed course mid-quarter when a handful of banks imploded practically overnight. The Fed intervened swiftly and decisively, in a move to protect depositors and prevent contagion within the banking system. Stocks resumed their climb and global stocks finished up +7.31%¹ by quarter’s end.

Not to be overshadowed, the bond market experienced its most volatile quarter since the Financial Crisis of 2008, as investors and the Federal Reserve struggled to digest conflicting data concerning the economy, inflation, and the health of the U.S. banking system. Like the stock market, bonds experienced a late quarter rally, closing up +2.96%.²

Unlike the stock and bond markets, our alternatives portfolio continued its upward trajectory without any significant volatility. Focusing on select private credit opportunities, the category continues to perform well and provide a high level of income and stability for the portfolio. For the quarter, our alternative private credit funds were up +2.16% (net of all fees).

While markets seem to have stabilized from shocks to the banking system, the crisis will likely have ongoing implications for the economy, financial markets, and our portfolios. For one, it will make the Fed’s job tougher as it continues to battle inflation by raising interest rates. Before the sudden demise of Silicon Valley Bank, markets were forecasting a high likelihood of the Fed continuing to raise rates through the end of the summer in order to choke off growth and bring down inflation. Since the banking crisis, though, markets are now pricing in a much more accommodating Fed. The chart below tracks market expectations about the Fed Funds Rate, the key rate set by the Fed. As the chart reveals, in just the last month the markets are now predicting lower rates, a shorter time for interest rates to peak, and a more aggressive cut to future rates. Bonds are likely to rally if this scenario plays out, as lowering interest rates should provide a tailwind for bonds.

In addition, small/mid-sized regional banks are now likely to be subject to greater regulation, and with these banks on their own tightening lending standards in anticipation of a weakening economy, lending from these banks will be sharply reduced. As a result, private lenders should have greater opportunities to make loans with higher yields and stronger covenant protections. Our alternatives portfolio (which is currently focused on private lending) should continue to perform very well in such an environment.