Market Has Bad BreadthThe S&P 500 is up about 3% to start the first quarter of 2023. On the surface things look good. But what if we look 'under the hood'. Most sectors are lower - especially those which are economically sensitive (like banks, energy, small caps and materials). However, big tech is carrying the market higher. That's not necessarily a good sign.
Yield Curve: Recession Dead Ahead2-year bond yields are cratering. Rarely - if ever - have we seen them fall 150 basis points in just three weeks. This signals the bond market sees aggressively rate cuts from the Fed this year. But what would cause this? A recession? Some kind of credit crisis? I can tell you it won't be because inflation is back to the Fed's target of 2%. What's more, the yield curve has steepened sharply. This isn't good... and if history is any guide... a recession is likely within 12 months.
Market vs The FedThere is strongly divided opinion on whether the Fed's decision to raise 25 bps this week was the right thing to do. What should the Fed prioritize? Financial stability or prices of goods and services? The Fed chose the latter. However, Powell added he does not see rate cuts in his base case for 2023. However, that's not what bonds are pricing in. They see the Fed cutting rates by a further 100 bps this year. A reckoning is coming... one of them has it wrong.
Why I Bought BACStocks are always climbing the "wall of worry". And there is no end of "worries" today. Perhaps front of mind is the current lack of confidence in the US banking sector. However, I think it represents a great long-term risk reward opportunity in quality large cap banks. Buy when others are fearful and sell when they are greedy. This post looks at why Bank of America could be a good bet... investors have rarely been this fearful.
Idiosyncratic or Systemic?Do you believe the current banking 'crisis' is idiosyncratic or systemic? The short answer is it's still far too early to know. Hopefully it's more of the former and less the latter. Because if it's the latter, that's a problem. Last week's issues will become multiplicative (vs additive). 2008 was a global systemic banking crisis.... this is not 2008. At least not yet...
The Fed Must ‘Choose their Poison’The collapse of SVB and tightening financial conditions has put the Fed in a very difficult spot. For example, prior to the collapse they had a green light to raise at least 25 bps. Not now. Tightening rates could cause further pressure in the banking sector. However, if they choose not to - what signal does that send. There are no easy choices...
Markets Suffer Worst Week for 2023Markets are in a state of panic. A small regional bank - Silicon Valley Bank - suffered a bank run this week. Over $42B was withdrawn in the space of just two days. What happened? On the surface it looks like very poor risk management - where SVB was effectively forced to sell long-term bonds which were underwater. Call it a margin call. Their interest rate risk was not adequately hedged. More details will come out in the coming days... however this sell off is taking the entire sector down with it. Is it warranted?
First Major CasualtyThis week saw the second largest banking collapse in US history and the first since 2008. Silicon Valley Bank - with a market cap of $18B only 4 weeks ago - collapsed Friday after a furious bank run. SVB's collapse was far less to do with the Fed raising rates - it was all to do with poor risk management - forced to sell their holding of treasuries at a loss. But this is nothing we have not seen before....
Powell’s PunchIn what was supposed to be a 'vanilla' testimony to Congress - Jay Powell turned this into a market moving event. Not pleased with how market participants interpreted his previous address - he set the record straight that rates will be higher for longer. His testimony left no room for ambiguity - it was full hawk. Markets quickly revised their forecasts for the peak Fed funds rate - with some now thinking 6.00%. What's more, the 2/10 yield curve is now negative 107 basis points. We have not seen that since 1981. Soft landing? Good luck.
What Do Credit Spreads Tell Us?There are two types of economic indicators which are often cited in the financial media: (i) those which lag; and (ii) those which are leading. The latter of more useful. One of the best real-time leading indicators are credit spreads. These are excellent indicator of the 'health' of the financial system. So what do they tell us today with interest rates sharply higher?
