Message from the Adviser (unaudited)
We are pleased to present the Semi-Annual Report for the PFM Multi-Manager Series Trust (the “Trust”) and the Trust’s PFM Multi-Manager Domestic Equity Fund (“Domestic Equity Fund”), PFM Multi-Manager International Equity Fund (“International Equity Fund”) and PFM Multi-Manager Fixed-Income Fund (“Fixed Income Fund”) (each a “Fund” and, collectively, the “Funds”), for the six months ended March 31, 2023.
The semi-annual period ending March 31, 2023 saw capital markets recover some of the losses of 2022. Equities saw a multi month rally that took the S&P 500 from 3,585 to 4,109. Bonds also saw better performance as the rate on 10-year Treasuries fell from 3.8% to 3.5%. Within the fixed income market, credit began to recover as spreads tightened. Commodities, on the other hand, continued to give up the gains they achieved in the first half of 2022. While a multi-asset class portfolio delivered healthy gains, the semi-annual period did end on a sour note due to the failure of Silicon Valley Bank (“SVB”) and investor concerns over the health of the banking sector. SVB was somewhat unique in that over 90% of its deposits were above the FDIC insured limit of $250,000 and many of its customers were startup companies in the technology and healthcare sectors. When it reported that it saw unrealized losses on its bond portfolio due to the Federal Reserve (“Fed”) aggressive tightening of monetary policy, it experienced a classic “run on the bank.” Contagion to other banks, especially small and mid-size banks, was short-lived as regulators immediately stepped in, insuring all deposits at SVB and offering liquidity to any bank that needed it, accepting collateral valued at par rather than market value. With concerns over the banking sector easing, equities and credit markets began to stabilize.
Despite pessimism that a recession may be just around the corner, the global and U.S. economy continued to grow. For the first quarter of 2023, the U.S. economy grew at a rate of 1.1% annualized. Adjusting for inventory drawdown, the growth rate in the first quarter was very healthy. While the U.S. economy defied expectations for a recession due to aggressive monetary policy, we would note that the healthy growth in the first quarter occurred mostly before the failure of SVB, which took place in mid-March. Due to concerns over a slowing economy, possible additional deposit outflows and possible losses in their commercial real estate loan portfolios, banks may further tighten lending standards. Tighter lending standards combined with continuing tightening of monetary policy by the Fed may tip the economy into a meaningful recession in the second half of 2023. As inflation continues to moderate and the Fed nears the end of rate increases, our base case remains that the U.S. economy is on track for a “soft landing”, but we do recognize that the probability of recession is elevated.
In addition to concerns over issues in the banking sector and possible policy errors by the Fed, the global economy continues to face geopolitical risks, including Russia’s ongoing invasion of Ukraine, a more assertive China, and North Korea continuing to build its nuclear program among other risks. In addition to geopolitical risks, the U.S. debt-ceiling conundrum further adds to the risks faced by the U.S. economy. The issue is more contentious than normal and even more uncertain than the 2011 debt-ceiling crisis where the U.S. credit rating was downgraded by rating agencies. Republicans have a small majority in the House and the Speaker has limited room for negotiations. On the Democratic side, President Biden has indicated that he wants a “clean bill” raising the debt ceiling and that any discussions about spending limits are to be separate. The so-called “X date” (when the U.S. Treasury will no longer be able to pay all obligations in full without delay) fluctuates between June and August. The Republicans have put forth a plan that raises the debt ceiling while reducing future spending, which is very unlikely to be approved by the Democratically controlled Senate. Similar to 2011, we may not get an agreement until the last moment. In 2011, both equities and credit markets saw significant volatility and declines prior to final agreement. We may see the same in 2023.
As a result of the significant decline in equity prices in 2022, equity valuations are not stretched at current levels. While analysts have reduced their estimates for corporate profits in 2023 due to pressure on margins, the trajectory of interest rates for the rest of 2023 and 2024 will likely have a significant impact on equity prices. The Fed is expected to end hiking rates and possibly lower rates later in 2023. If rates do come down, it would likely drive equity prices higher as valuations expanded even in the face of lower profits. Lower interest rates, provided the economy avoids a recession and default rates remain low, would also benefit credit markets as spreads continue to tighten. Capital markets are likely to continue to remain volatile as various risks are currently elevated. While we expect capital markets to remain volatile, if we avoid a recession, we believe that equities, credit and other economically sensitive asset classes are likely to continue to recover the losses they suffered in 2022.
While nominal wage growth has been robust as companies faced labor shortages, adjusted for inflation, the average consumer has seen living standards and net worth deteriorate. Negative real wage growth combined with a saving rate that has declined from the pandemic high, means the U.S. consumer, while currently in good financial position, may come under pressure later in the year. The labor market remains strong with a historically low unemployment rate, but we are beginning to see cracks, with rising jobless claims, lower job openings and fewer workers quitting their jobs.
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