Market Report – Spring 2023

The stock and bond markets went for a bouncy ride for the first quarter which ended with the markets higher. For the period, large-company stocks were up 7.50%, small-company stocks were up by 2.7%, and foreign stocks were up 8.50%. Bonds increased for the quarter by 3.00%.

High inflation has dominated the headlines and impacted consumer pocketbooks since it started to rise in the second half of 2021. At the time, senior government officials expected the inflationary surge to be “transitory” before receding, though it proved more stubborn than expected, and in fact accelerated as the months went by. Because excessive inflation can lead to “hyperinflation” and economic calamity, the Federal Reserve takes its role in containing it very seriously.

The Fed has followed its customary playbook of raising interest rates in an effort to rein in inflation. Higher interest rates tend to slow the economic growth that fuels inflation. The nine consecutive interest rate hikes over the last year were supposed to put the brakes on growth. However, low unemployment, robust consumer spending, and other factors have served to invigorate the economy, undermining the inflation-fighting effects of higher interest rates.

In the wake of those rate hikes, there were some signs of cooling inflation toward the end of last year. To the surprise of many, both consumer spending and hiring came storming back in January, prompting a reassessment of the challenge at hand.

That challenge is in part defined by competing prospects for a so-called “soft landing” or “hard landing” for the
U.S. economy. These terms refer to the scenarios that Fed interest rate hikes may either merely slow the economy (the preferred soft landing) or slow it too much and trigger a possibly severe recession (hard landing.) The extraordinary pace of rate hikes has raised concerns about whether the Fed might “break” some part of the economy through too much pressure caused by the hikes.

If not a “break” then certainly a loud creak came from the economy in March as two high-profile U.S. banks collapsed, and government regulators took control.

The reasons for the failures of Silicon Valley Bank and Signature Bank are complex, though in each case, the fast pace of rising rates was a factor.

Each bank was a member of the Federal Deposit Insurance Corporation (FDIC), so depositors were insured up to
$250,000 in deposits, though there were individual and corporate depositors with far more than that held in these banks. A decision was made at the federal level to expand coverage to all assets held at these banks, effectively making all depositors whole, while stock owners (also the shareholders of each bank) were wiped out.

Many Natural Investments clients’ investments are held with Charles Schwab & Co. which is a well-known brokerage firm established in 1975. Although related, Charles Schwab Bank is a separate, chartered bank and FDIC member. Modest cash balances may be held with Charles Schwab Bank within Schwab investment accounts and enjoy FDIC insurance for balances up to $250,000. Schwab Bank maintains an A+ rating from credit rating agency, Fitch Ratings.

Anytime stock investors are “wiped out,” a teachable moment is generally at hand. It could be argued that risk-taking at these banks was excessive by evidence of their collapse when interest rates surged. As risk and return are correlated, bank executives took risks to increase profits for the benefit of the shareholders, which included bank executives. In other words, this may have been a situation where better corporate governance could have helped avoid this unwelcome outcome. The G in ESG represents corporate governance, or the rules, practices, and processes used to run a company. Good corporate governance in the eyes of socially responsible investors means companies ensure that ethics and transparency are central in governance processes.

In addition to high-risk strategies, businesses can be tempted to enhance profits through other means such as externalizing costs, the practice of discharging business costs to other entities such as labor, government, communities, public health, or the environment. For example, a business might release toxic waste into a river (saving itself from the cost of treatment), thus externalizing the cost of downstream remediation work to the public.

Likewise, banks, similar to other public companies, can be motivated to amplify profits that enhance, in Wall Street parlance, shareholder value—except “value” here equates entirely with money—in the form of shareholder financial gain.

A more thoughtful motivation for a business/shareholder team is an understanding of shareholder value that emphasizes sensitivity toward the wellbeing of employees, customers, communities, environment, as well as a company’s own profitability. This represents an enlightened move from “shareholder value” to “stakeholder value” and is a central tenant of genuine socially responsible investing.

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