Cutting Through the May Daze

The S&P 500 posted back-to-back gains in March and April, bringing year-to-date returns to nearly 10%. If you had not read the headlines, you’d never have guessed that on May 1 the U.S. would see its third major bank failure in as many months. In the days following, the Federal Funds target Interest rate reached a 16-year high, rumors of further bank failures circulated, and the Department of Labor surprised the market with an unexpectedly robust jobs report.

Beneath the surface of a resilient market and economy, the stresses of rising interest rates continue to reveal risks lurking below. If interest rates stay elevated, we believe regional banks will continue to face significant headwinds caused by the ongoing shift of deposits to larger money center banks and money market funds. In this context, we are reaffirming our guidance to clients to 1) maintain a modest underweight to growth assets and 2) prepare stability assets to deliver the liquidity and diversification necessary to position portfolios for the opportunities to come.

The past decade has been difficult for the property insurance industry, with the past three years in particular bringing one natural catastrophe after another. Insurance premiums for automobile, collections, and homeowners have also been affected by the increase in claim severity related to the rising costs of repair, led in turn by inflation and supply chain issues. Prolonged claims settlements caused by supply chain issues and shortage of skilled labor also contribute to increased claims costs for loss of use or temporary replacement of housing or vehicles, which then leads to higher premiums.

Additionally, reinsurance costs have been rising steeply, with double-digit increases in the past two years, and they are projected to increase another 25-40% in 2023. (Reinsurance is insurance purchased by carriers to partially insulate themselves from catastrophic claims events.) These costs are passed along to consumers in their policy premiums and are most apparent in catastrophe-prone areas like California, Florida, and remote places where fire department response times are longer or unavailable.

The challenges faced by the industry were further exacerbated by Hurricane Ian’s landfall in September 2022, resulting in an estimated $67 billion of insured losses, surpassing the cost of Hurricane Katrina in 2005.

April marked the first month since April of 2022 where the S&P 500 had positive year-over-year returns. Payroll data came in above expectations and inflation cooled to its lowest level in almost two years. The Fed hiked interest rates again to 5.25% despite ongoing issues within the banking sector. The treasury yield curve continued to get more inverted, but equity markets have shrugged off all signs of distress up to this point as the S&P 500 is up over 9% YTD.