The year started off with a strong performance in both equity and bond markets, with returns firmly in the green for the first quarter. While there was some levelling off in February and March, the overall trend was positive, largely due to a retracement of the investments that had suffered the most in the previous year.
However, there were also risks evident in the system, particularly with the impact of higher interest rates. The collapse of Silicon Valley Bank in March highlighted these risks. Despite this setback, equity markets performed well during the quarter, while credit spreads widened, making fixed income relatively more attractive.
Below we outline some brief highlights from the past quarter:
Banking Crisis
On March 17th, Silicon Valley Bank (SVB), the 16th largest bank in the U.S., filed for bankruptcy protection. The previous week, concerns had started to materialize as the bank experienced a run on deposits. There were several factors that contributed to SVB's failure. Firstly, central banks had been raising interest rates at a considerable pace, which had a negative impact on the start-up technology companies that SVB relied upon for growth. Secondly, SVB had mismanaged their assets by investing in longer-duration bonds. As their business began to suffer, SVB clients started to withdraw deposits, and the bank was forced to sell their investments at a loss.
To prevent a bank crisis similar to the one that occurred in 2008, U.S. regulators immediately took action to ease public concerns and prevent a further run on banks. They created an emergency support package, which included the Federal Deposit Insurance Corp (FDIC) promising to fully protect all depositors for SVB. Additionally, the Fed announced the creation of a new Bank Term Funding Program that provided easier access to loans for banks, creating a buffer to assist banks when clients withdraw cash.
Equity markets were strong in Q1 2023
The first quarter of 2023 was positive for equity markets, with the Nicola Canadian Equity Income Fund, Nicola U.S. Equity Income Fund, and Nicola Global Small-Cap Equity Fund all returning around 4%, while the Nicola International Leaders Fund returned 9.2%. Unlike the fourth quarter of 2022, which saw a bifurcation in the marketplace, Q1 2023 was anchored in interest rate expectations and saw a strong relief rally in technology names.
The Nicola International Leaders Fund benefited from a strong recovery in the share price of developed markets in Europe, particularly in Germany, France, and Spain, as there is a growing consensus that Europe will be able to manage through the energy crisis. The Fund also gained from exposure to European luxury goods producers. Although we continue to believe that China will no longer be the global growth engine and has structural challenges related to demographics, the reopening of its economy has been rapid and supportive of positive sentiment on consumer spending for luxury goods providers.
Currency volatility within the quarter
At the beginning of the year, the U.S.-Canadian Dollar pair started at $1.36 and ended the quarter at $1.35. However, there was significant volatility within the quarter, with the Dollar dropping to as low as $1.33 and rising to as high as $1.38 before settling at similar levels to the start of the quarter.
While inflation moved lower, it is likely still too high for the Fed, and their decisions going forward will be influenced by the tightness of financial conditions and unemployment levels. We anticipate that interest rate volatility in both Canada and the U.S. will remain high, resulting in higher currency volatility for the foreseeable future.
Credit spreads moved wider
The impact of Silicon Valley Bank on markets was significant, with credit spreads widening across the board, particularly in the banking sector. Another troubled bank, Credit Suisse, is set to be acquired by UBS, potentially leaving some Credit Suisse bondholders with nothing. As a result, credit spreads have widened further and are now at more attractive levels.
The impact of concerns on the banking sector has both direct and indirect effects on the markets in terms of risks. Recent bank failures have put overall pressure on the banking industry, leading to potential implications for future lending practices. Tighter lending conditions may result in a negative impact on economic growth potential as it becomes more expensive and difficult for companies and individuals to borrow.
This material contains the current opinions of the author and such opinions are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information presented here has been obtained from sources believed to be reliable, but not guaranteed. Returns are quoted net of fund/LP expenses but before Nicola Wealth portfolio management fees. Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Please speak to your Nicola Wealth advisor for advice based on your unique circumstances. Nicola Wealth Management Ltd. (Nicola Wealth) is registered as a Portfolio Manager, Exempt Market Dealer and Investment Fund Manager with the required securities commissions. This is not a sales solicitation. This investment is intended for tax residents of Canada who are accredited investors. Please read the relevant documentation for additional details and important disclosure information, including terms of redemption and limited liquidity.
