In the first quarter of 2023, the market continued its rebound off the October 2022 low and many of last year’s biggest losers became 2023’s best performers. The S&P 500 peaked on February 2, a 16% gain from the October low and a welcome change after painful losses in 2022. Soon after, the closure of Silicon Valley Bank in California and Signature Bank in New York caused flashbacks of the Great Financial Crisis after a three-year period of no bank closures. The remainder of the quarter was volatile as the market repositioned around this perceived “banking crisis” and anticipated regulatory responses. During this time, the market narrowed and favored large cap technology companies and communications stocks (exemplified in the NASDAQ Composite below), which had underperformed the market considerably in 2022. Through the end of the quarter, large cap equities outperformed small and mid-cap issues; growth outperformed value benchmarks.
Source: Orion. Data as of 3/31/2023
The collapse of Silicon Valley (“Silly”) Bank and Signature Bank seems to be a convergence of events around rising interest rates, poor risk management, lax regulation, and human emotion. We used the broad selloff in financials to increase our exposure to higher quality businesses during this time of fear. In Winston Churchill’s words “Let no crisis go to waste”. Historically, periods of fear represent buying opportunities for quality companies that are being put “on sale” and tend to be rewarded 6 to 12 months later. For Heron Bay clients, the net result during the recent bank run was the sale of Fifth Third Bank, which we previously were selling over the previous two months, and Regions Bank to purchase LPL Financial and Charles Schwab. Both LPL Financial and Charles Schwab make money from excess cash in their client portfolios, which tends to increase in times of volatility. We don’t fundamentally believe that LPL and Schwab will be adversely affected in the long-term by depository outflows, money market repositioning, or regulatory response facing regional banks. We believe that Charles Schwab and LPL Financial are positioned for long-term growth as they consolidate their industries.
Before the banking issues in February, the Federal Reserve increased short-term interest rates at a historically rapid clip while shrinking its balance sheet in an attempt to bring inflation to the Fed’s 2% annual target. Unfortunately, as we experienced in 2022, rising interest rates act like gravity on asset prices. The Fed has repeatedly stated that they will continue to raise rates and are willing to accept some “breakage” and unemployment to achieve their objectives. However, as the banking situation unfolded, interest rates declined as investors sought safe haven assets and the Fed provided liquidity from its balance sheet, negating much of the Fed’s previous activity. Cautious banks that are less likely to lend can do much of the Fed’s heavy lifting by shrinking the money supply. Chairman Powell and other FOMC Committee members continue to voice a need to “stay the course” while the bond market is forecasting that the Fed will need to lower rates sometime in 2024. While this disequilibrium of market expectations and Fed rhetoric continues, the bond and stock market are likely to continue to experience continued volatility. In the face of uncertainty, we are seeing businesses thin their work force while focusing on productivity and profitability. Moonshot projects, to the extent that they are optional, are being tabled and CEOs are preparing for the potential of a slower growth economy in the future.
As we have communicated in the past, our disciplined focus and capital concentration on quality companies of sound financial condition, low levels of debt, high profitability and cash flow generation should provide for the resilience necessary to thrive in this environment. We are watching the markets closely and adding capital to strong companies as they hit our price targets.
As always, we are grateful to be able to serve clients and we look forward to speaking with you all soon.
Disclosure
Heron Bay Capital Management, LLC (“HBCM”) is a registered investment advisor. Advisory services are only offered to clients or prospective clients where HBCM and its representatives are properly licensed or exempt from licensure.
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