Pro Perspectives 4/26/23

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April 26, 2023
 
As we discussed yesterday, there is renewed pressure on First Republic Bank – the still standing, but still troubled bank that was exposed in the banking shock of last month.
 
With that, when the Fed releases it's weekly report of securities holdings tomorrow, we'll find out if this renewed stress results in another impulse of Fed balance sheet expansion.  
 
Below is what the Fed's job of "lender of last resort" looks like when they have to provide liquidity to a banking system that's having or fearing a liquidity shock.  In this case, it was a depositor run on a few banks last month.    
The Fed stepped in and plugged the gap with "loans." And, in coordination, the Fed and Treasury implicitly assured the safety of deposits in the banking system, but stopped short of an explicit emergency guarantee of all deposits (to include uninsured depositors beyond the failed Silicon Valley Bank and Signature Bank).
 
But, while the two banks that failed last month, and the teetering First Republic Bank, share(d) commonalities of an unusually high percentage of uninsured deposits, and an industry high duration mismatch (between asset and liability maturities), the real culprit in this meltdown was the depositor panic.  Moreover, how quickly it spread through social media.
 
All of that said, arguably, the trigger was the Fed's tone-deafness to the stress it has created from this tightening cycle.  That said, the interest rate market is pricing in about a 75% chance of, yet another, Fed rate hike next week. 
 
But we have a Q1 GDP report tomorrow, which looks like it will come in lower than had been projected now, given the downgrade in today's updated Atlanta Fed model (was +2.5%, now +1.1%).  And this appears to be driven by the lower revisions to January and February retail sales data (revisions that were released on Tuesday).
 
So this sets up for a negative surprise tomorrow.  And then we have the Fed's favored inflation gauge, core PCE (monthly, March), on Friday. 
 
This, while First Republic will likely require more attention from the Fed, FDIC and Treasury.  This may all be setting up for a positive surprise from the Fed next Wednesday (i.e. a pause). 
 
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Pro Perspectives 4/25/23

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April 25, 2023
 
As we discussed yesterday, earnings estimates have been dialed down, with Wall Street expecting a 6.7% contraction in S&P 500 earnings for Q1, in a quarter where the Atlanta Fed is tracking GDP growth at 2.5%. 
 
That said, we’ll get an update to that Atlanta Fed growth projection tomorrow, and we’ll get the first government estimate for Q1 GDP on Thursday.  But clearly, there is potential here for someone to be wrong.  
 
And at the moment, it looks like it’s Wall Street.  Today we had another day of big positive surprises on the earnings front.  And in many cases, revenues have come in higher than expectations too.  
 
Microsoft.  3M.  Google.  Biogen.  Chipotle.  GE.  McDonald’s.  Kimberly Clark.  Visa.  GM.  Haliburton.  Pulte.    
 
The broad economy is well represented in these stocks.  All beat earnings and revenue estimates.
 
It was a record quarter for Chipotle.  Microsoft, a $2 trillion company, had record revenue and record net income.  Pulte Homes grew revenue by 12% compared to Q1 of last year, with 28% EPS growth … despite being faced with the fastest doubling in mortgage rates on record.
 
This all sounds pretty good. 
 
What about the renewed fears surrounding banks, that led to this today …
Remember, First Republic Bank (FRC) was one of the three vulnerable banks (high uninsured deposits, large duration risk) that were harmed by a run on deposits last month.  Two failed, but FRC was preserved via an infusion of deposits from a consortium of big banks (arranged by the Treasury).   They reported yesterday after the close, and divulged the exit of half of depositor assets in the run (excluding the Treasury arranged infusion). 
 
With that, stocks (and interest rate markets) behaved today as if a banking shock might be turning into a banking crisis. 
 
But remember, the Fed is back in the business of expanding the balance sheet (QE).  They've given banks unlimited access to short term liquidity to meet demand of depositors (a crisis averting backstop).
 
That said, after doing nearly $400 billion of QE in March, as the fears quelled, the balance sheet shrank for the past four consecutive weeks (as you can see in the chart below, to the far right).
After today's events, I suspect we'll find the balance sheet is expanding again.   

 
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Pro Perspectives 4/24/23

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April 24, 2023
 
It's a big earnings week.  
 
As we discussed coming in to this earnings season, expectations have been dialed down.  That creates an opportunity positive surprises.    
 
With that, coming off of a major shock and potential broad threat to banks last month, the first hurdle to clear, in this Q1 earnings season, was the big banks. 
 
That was done successfully.  The big banks posted big earnings beats, even AFTER adding to their respective war-chests of loan loss reserves.
 
We've since heard from the, perceived-to-be, more "at-risk" regional banks — including those that share the threatening combination of high uninsured deposits and large duration risk (characteristics akin to the bank failures of last month).  The good news:  We've seen a fair share of earnings beats in those reports, and cases of muted or successfully tamed deposit flight.  
 
Overall, better than half of the companies that have reported in the financial sector have beat earnings estimates, thus far.  
 
More broadly, in quarter where the bar was set very low for earnings expectations, 76% of S&P 500 companies that reported as of Friday had beaten expectations. 
 
That said, this week, we'll hear from big tech companies, along with broader corporate America.
 
Keep in mind, these earnings are from a quarter that the Atlanta Fed continues to project GREW at a 2.5% annualized rate.  That's in contrast to Wall Street's expectations for a 6.7% contraction in earnings for S&P 500 companies — which would be the biggest decline since the depths of the covid shutdown. 
 
With this setup, we enter the heart of earnings season with sentiment readings leaning bearish.  Speculators are net short S&Ps at levels not seen since October 2011 (when the European sovereign debt markets were in crisis).  And the Bank of America global fund manager survey shows most bearish on stocks, relative to bonds, since 2009.  
 
These tend to be contrarian indicators. 
 
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Pro Perspectives 4/20/23

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April 20, 2023
 
We continue to hear chatter about looming recession. 
 
For perspective, we had a technical recession in the first half of last year.  It was (textbook) two consecutive quarters of negative GDP growth.  And it was driven by burdensome inflation and (textbook) expectations of an impending tough period of monetary policy tightening. 
 
Still, the government denied that it was a recession.  That denial was somehow broadly accepted by the public.  And since, all we've heard about is impending recession.  
 
That narrative has been promoted for the better part of the past three quarters now (quarters of actual growth).  The economy grew in both the third and fourth quarter of last year.  And Q1 of this year is still projecting a healthy 2.5% annualized growth (data still coming in).
 
But we've since had the introduction of a catalyst that would, very likely, in a normal world, induce an economic contraction:  last month's shock in the banking system.
 
That said, we're not in a normal world. 
 
In the post-Great Financial Crisis era, we know how policymakers will respond.  They will intervene.  They did, quickly.  The Fed rotely went back to expanding the balance sheet (backstopping troubled banks with "loans"). And the Treasury summoned the Financial Stability Oversight Council (FSOC), the group designed to "mitigate risks to the U.S. financial stability," and risks were quickly mitigated.
 
A month later, and the dust has settled.  Banks are reporting Q1 earnings, some with quite good performance.  The mass deposit flight risk appears to be have been managed (via intervention), if not overstated.
 
With that, the Fed's balance sheet has gone back into reverse, shrinking now for a third consecutive week.  And money market fund assets, where some depositors fled to, have reversed (shrunk) for the first time since early March.
 
Add to that, with Fed members finally voicing some dissenting views on the next move, perhaps the environment is shaping up to be better for the economy and markets than sentiment would suggest.  
 
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Pro Perspectives 4/19/23

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April 19, 2023
 
The March UK price data, released early this morning, showed double-digit inflation. 
 
This was the Wall Street Journal headline …
Given that the Fed (the global interest rate anchor) is clearly contemplating the end of the road for the tightening cycle, a big inflation number in Europe, in a month that should have reflected tightening global credit conditions, set off some alarms.  Rates went higher, stocks went lower and commodities went lower – globally.

 
But it was a false alarm. 
 
By this time next month, it's a good bet this same reading in the UK will have plunged. 
 
Why?  The "base effect."
 
The April inflation data will be measured against a significantly higher data point from twelve months prior.  
 
Here's a visual, for perspective …
Even if April (this month) were to bring about a hot inflation number in the UK, the year-over-year CPI will likely land somewhere within the white box on this chart below.  So, this time next month the media will be talking about an acceleration in the trend of "disinflation" in the UK.
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Pro Perspectives 4/18/23

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April 18, 2023
 
Let's take a look at mortgage rates.
 
As you can see in the chart below, the spread between the 30-year fixed mortgage rate and the U.S. 10-year Treasury yield is at extremes.  It runs about 2% on average, over this 20-year history.  It's closer to 3% at the moment. 
The blowout of this spread was triggered by the Fed's early telegraphing of an 80s, Volcker-like inflation fight.  That type of response would have entailed a double-digit Fed Funds rate.  Thankfully (for the economy) that didn't happen, but mortgage rates took the cue, and doubled at the fastest rate in history.  
 
Of course, another driver of this spike in mortgage rates was the Fed's stated intent to shrink the balance sheet, which would (expectedly) entail reducing its position (its bid) in the mortgage-backed securities market.
 
That said, the Fed was noticeably very cautious in its attempt to trim the $2.7 trillion mortgage portfolio.  It was four months into the "quantitative tightening" program, before they even made a ripple in their mortgage holdings.  Still, they are well behind on the planned asset sales, and probably for the reasons exposed in the chart (i.e. the risk of further disconnecting mortgage rates from the broad interest rate market, and therefore breaking the housing market).
 
We've already seen the Fed's response to its self-induced banking crisis:  They started buying Treasuries again. 
 
I suspect, soon, the Fed will have to start buying mortgages again, too (to normalize the spread).  The catalyst:  the trouble brewing in commercial real estate. 
 
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Pro Perspectives 4/17/23

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April 17, 2023
 
I'm back in action, following a week-long tour of colleges for my son.
 
We left off prior to Easter, heading into the March employment report. 
 
As we discussed, the employment situation had already given signals of softening.  The ISM services employment index for March was weaker than the prior reading.  The ADP report for March showed the weakest job gains in more than two years.  And the measure of "job openings" (JOLTS) had already contracted by nearly a million jobs — and that was before the effects of the banking fallout. 
 
With that, the BLS job report for the month of March did indeed show slower job growth.  The economy added 236k new jobs — quite a bit slower than the average monthly job additions of 334k over the prior six months.
 
Of course, this is of particular interest as the Fed has explicitly targeted the hot jobs market over the past year as a pain point for inflation (related to the leverage that workers have to negotiate higher wages).  With the justification of oversupplied jobs, they have mechanically stepped interest rates higher, with the intent of job destruction and, therefore, demand destruction (and therefore, bringing inflation down).  
 
So, again, the employment situation is now clearly softening.  And we also learned last week that the inflation data continues to soften.
 
And remember, the Fed Funds rate is now ABOVE, their favored inflation gauge (core PCE).  And historically, raising rates above the inflation rate has been the antidote to inflation.
 
Add to this, the shock in the banking system last month, should have signaled to the Fed that they've hit the intolerance level for interest rates.
 
So now, post-banking system shock, the already softening economic data will be exacerbated by a slowdown in bank lending.  This, and the 475 basis points of Fed tightening still hasn't worked its way through the economy. 
 
With this backdrop, the next Fed meeting is in two weeks.  This tightening cycle should be over.   
 
That said, the interest rate market is pricing in a near 90% chance of another quarter point hike. Given this market expectation, a "pause" by the Fed would be a positive surprise for stocks. 
 
We have also entered Q1 earnings season, with a low expectations hurdle – expectations are for earnings contraction of 6.5%.  Thus far, the big banks have posted big earnings beats, even AFTER adding to their respective war-chests of loan loss reserves.     
 
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Pro Perspectives 4/7/23

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April 7, 2023
 
Markets were closed today in observance of Good Friday. 
 
I’ll be away next week, so you will not receive a note from me.
If you’re a Billionaire’s Portfolio subscriber, it’s a great time to get your portfolio in line with ours.  You can find all of my past notes and the full portfolio here.  If you’re not yet a member, you can get involved by clicking here.
Happy Easter!
Best,
Bryan
 

 

Pro Perspectives 4/6/23

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April 6, 2023
 
Stocks are closed tomorrow for Good Friday.  But we will still get the March jobs report at 8:30.
 
With this jobs report in mind, remember, it was mid-March that bank runs started on a few vulnerable venture capital related banks.  Not only did that send shock waves through the banking sector, but it had a clear and direct blow to the technology sector. 
 
It was safe to assume, that confidence shock had a direct and indirect effect on jobs.  And we’ve already seen it reflected in some March employment data. 
 
The ISM services employment index for March came in quite a bit weaker than the prior reading.   
 
Wednesday’s ADP jobs report for the month of March was weak.  In fact, it showed the second weakest job gains in more than two years.
 
And as you can see in the chart below, the six-month rolling average of jobs added in the ADP report, have been going one direction since the Fed started raising rates last year (down).  This average has returned to pre-covid norms.
Of course, the Fed has explicitly threatened jobs along the path of its inflation fight.  
 
And Jerome Powell has specifically targeted the mismatch between job openings and job seekers.  We heard more on that front earlier this week.  It was February data (prior to the banking fallout), but already nearly a million jobs had evaporated.  This job openings/job seekers ratio has probably since collapsed. 
So, this brings us to tomorrow morning’s government published jobs report.  It’s a safe bet that it will be soft.
 
This number was running around 200k (on average) prior to covid.  Wall Street consensus for March is around 250k.  This, and the trend of the six-month rolling average, is all in-line with the data points mentioned above (i.e. a weaker employment situation).
 
If we needed anything else to confirm to the Fed, that they should avoid another mistake with interest rates, this (a soft jobs report) should do the trick.
 
With that, a soft jobs report should be good for stocks. 
 
But, given that influence on the rate outlook, it should be bad for an already declining and vulnerable dollar.     
 
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Pro Perspectives 4/5/23

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April 5, 2023
 
Let’s revisit the long-term dollar cycles, which we’ve kept an eye on throughout the history of my daily note. 

Since the failure of the Bretton-Woods system through the onset of the Global Financial Crisis, the dollar traded in five distinct cycles – spanning 7.4 years on average.  
As you can see, the era of QE has seemingly distorted these cycles. 
 
Let's call this current cycle, an exceptionally long bull cycle for the dollar.
 
The top was October.  And now with the events of the past month, the fundamental picture for the dollar is clearly negative.  The rate outlook has swung dramatically, from tighter to easier, by year end.  And the dollar's world reserve currency status is simultaneously and opportunistically being challenged.
 
So, if we assume this extraordinarily long bull cycle for the dollar ended in October, we are just five months into a new bear cycle. 
 
It's very, very early.  And the average change in the value of the dollar (in the prior five cycles), from extreme to extreme is > 50%. 
 
So, in this case, this bear cycle would portend a better than 50% decline in the global purchasing power of the dollar (relative to a basket of major currencies).
 
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