Good afternoon,

Global markets have been relatively calm and remain near their highs for the year. Despite the quiet market action, it’s been a rather busy period with developments that are worthy of updates.The first quarter earnings season has come and is nearly gone. Overall, it is looking as though the rate of earnings growth has declined year over year, for the second consecutive quarter. Clearly, that’s not great news. But, relative to low expectations, the results can be characterized as being “not that bad”. Moreover, the declines have been modest and come after a few years of very strong growth. Importantly, the commentary from management teams has been reasonably balanced, with some highlighting softness among lower-income households and in areas like spending on durable goods, and others pointing to strength and resilience in some industrial end markets and spending on travel and casual dining for example. Lastly, companies suggested inflationary pressures remain but are also moderating in some cases, with supply chain improvements a notable tailwind. Many companies acknowledged the uncertainty that lies ahead, but few flashed any notable warning flags.

The markets were faced with another failure of a U.S. bank over the past week. First Republic Bank, based in California, had similar characteristics to the couple that failed nearly two months ago: regionally focused with a high proportion of uninsured deposits (ie. greater than $250,000) given a concentration of wealthy clients. Yet, markets largely shrugged off the news, believing it was a foregone conclusion. We have concerns about the regional banking sector, believing there may be other smaller banks that are vulnerable to deposit outflows. It may require more intervention from regulators; however, we also believe these pressures are confined to a subset of the sector, and don’t present a larger systemic risk. We see three implications: 1) consolidation, which is already under way; 2) a further tightening of financial conditions as regional banks may be more selective with their lending practices; and 3) heightened regulatory scrutiny, particularly for banks of a smaller size.

The U.S. Federal Reserve and European Central Bank both raised interest rates by 0.25% over the past week. In the case of the latter, it indicated there is “more ground to cover”, implying there may be additional rate increases coming over the next few months. In contrast, the U.S. Federal Reserve signaled it may be done with its rate hikes as it altered the language in its formal statement in what Chairman Jerome Powell indicated was a “meaningful change”. It indicated it will take into consideration the cumulative action taken so far and the “lags” with which rate hikes tend to impact growth and inflation. The debate has already shifted to whether interest rates will stay where they are for the foreseeable future, or whether they could be lower by the end of the year, as some market participants expect. We believe it remains premature to think about lower rates given the stickiness of inflation.

Overall, these developments were incrementally positive. Corporate earnings haven’t been too bad, strains in the regional banking sector have been well absorbed by markets, and interest rates appear to be peaking which marks an important inflection point. Nevertheless, like the Fed, and the Bank of Canada which has officially paused its rate tightening campaign, we expect the significant rate hikes from the past year to eventually weigh on economic activity and corporate earnings in a bigger way.

Should you have any questions, please feel free to reach out.

Thom