As if the economic outlook weren't already hard to predict... 🤦🏻♂️
As if the economic outlook weren't already hard to predict... 🤦🏻♂️
Plus a charted review of the macro crosscurrents 🔀
After a volatile couple of days, stocks ended higher last week, with the S&P 500 climbing 1.4%. The index is now up 3.4% year to date, up 11% from its October 12 closing low of 3,577.03, and down 17.2% from its January 3, 2022 closing high of 4,796.56.
Turmoil in the banking system has made for a murkier outlook for the economy.
“Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation,” the Federal Open Market Committee (FOMC) said in its monetary policy statement on Wednesday. “The extent of these effects is uncertain.” (Emphasis added.)
In other words, the odds of getting turned down for a loan may have gone up by an uncertain amount as banks assess the uncertain outlook for their deposits and regulation.
“Such a tightening in financial conditions would work in the same direction as rate tightening,” Fed Chair Jerome Powell explained during the post-FOMC meeting a press conference. “In principle as a matter of fact, you can think of it as being the equivalent of a rate hike or perhaps more than that, of course it's not possible to make that assessment today with any precision whatsoever.”
While the woes in the banking sector may not have been intended, their effect on financial conditions are generally in line with what the central bank has been aiming for in its ongoing effort to bring down inflation.
For more on this unexpected turn of events, read Same destination, but now a more treacherous path 🚧.
In financial markets, uncertainty puts downward pressure on stock prices as investors demand more return for their capital. Though, this uncertainty premium also helps explain why returns tend to be relatively high in the stock market.
While nothing is ever really certain, the quotes above suggest Fed officials are particularly uncertain about what comes next.
“The future depends on two hard-to-predict behaviors,” UBS economist Paul Donovan wrote on Friday. “Will bank investors and depositors keep moving their money? And if they do, will loan officers respond by tightening lending standards?”
To recap: This whole thing began when wary Silicon Valley Bank depositors quickly withdrew their cash in a run on the bank. In response, the Federal Reserve, Treasury, and FDIC announced that all of the bank’s depositors, including uninsured depositors, would be made whole — essentially signaling to every American bank depositor that all their cash is safe.
While policy makers sound pretty serious about the safety of everyone’s deposits, who knows what people will do upon hearing about turmoil in the banking system? Sure, overhauling how you manage your cash is time-consuming. Still, that won’t stop at least some people from taking their cash and moving it elsewhere. If enough people do this, the result would be more financial instability.
All eyes on the Fed’s H.8 report 📋
According to the Federal Reserve’s H.8 report published Friday, bank deposits fell by $98.4 billion to $17.5 trillion in the week ending March 15, the largest one-week decline since April 2022. From Bloomberg:
The decline was entirely due to a record plunge in deposits at smaller institutions… Deposits at small banks slumped $120 billion, while those for 25 largest firms rose almost $67 billion. So-called “other” deposits, which exclude accounts with maturity dates such as certificates of deposit, declined by $78.2 billion to $15.7 trillion. Compared with a year ago, these more liquid deposits such as savings and checking accounts have declined by 6.1%, the most in data back to the early 1970s.
So it appears that at least some people moved their deposit from smaller banks to larger banks.
That leads us to lending. With uncertainty regarding deposits, banks seem likely to be more cautious in their lending. And tighter lending standards are a headwind to economic growth.
During the week ending March 15, bank lending jumped by $63.4 billion to $12.2 trillion.
“Of course, it’s too early to see any potential effect on credit supply, but both large and small banks saw decent gains in loans (though there could be some tapping of credit lines in anticipation of tighter credit conditions later on, something that occurred early in the GFC),” JPMorgan economist Michael Feroli wrote on Friday.
It’s unclear what to make of any of this as it’s one week’s worth of data. But it’s possible that the worst is behind us.
“One thing that seems more unambiguously positive was Powell’s remark on March 22, a week after the reference date on this report, that ‘Deposit flows in the banking system have stabilized over the last week,’” Feroli noted.
At least we’re talking about it 👍
If there’s a silver lining, it’s that everyone’s now got banking turmoil on their minds.
According to Bank of America’s March Global Fund Manager Survey, “systemic credit event” — which is just a fancy way of saying “big problems at the banks” — has overtaken “inflation stays high” as the top risk.
And recall TKer Truth No. 8: “The most destabilizing risks are the ones people aren’t talking about.“
Before a few weeks ago, few were concerned about a systemic credit event. Now, many are concerned. And as we discussed recently on TKer, markets will go haywire when a little-known risk suddenly emerges as traders and investors scramble to price in the downside.
Now that we’ve had a few weeks to price in a lot of concerns, we have to consider the possibility that things turn out better than what may now be priced into the markets.
This story is still unfolding, so unfortunately, it may be weeks or months before we can see things more clearly in hindsight.
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Related from TKer:
Reviewing the macro crosscurrents 🔀
There were a few notable data points from last week to consider:
🏛️ The Fed hikes rates. On Wednesday, Fed Chair Powell reiterated the central bank’s commitment to bring down inflation with increasingly tight monetary policy.
“My colleagues and I understand the hardship that high inflation is causing, and we remain strongly committed to bringing inflation back down to our 2% goal,” Powell said during its post-FOMC meeting press conference. “Price stability is the responsibility of the Federal Reserve. Without price stability, the economy does not work for anyone. In particular, without price stability, we will not achieve a sustained period of strong labor market conditions that benefit all.”
Powell made these comments after announcing another 25 basis point interest rate hike, a move that surprised some Fed watchers who expected the central bank to pause amid turmoil in the banking sector. It was a unanimous decision by the Fed’s 11-member FOMC.
“We will continue to closely monitor conditions in the banking system and are prepared to use all of our tools as needed to keep it safe and sound,” Powell said. “In addition, we are committed to learning the lessons from this episode and to work to prevent events like this from happening again.“
While reiterating that the disinflationary process is underway, with inflation significantly off its highs, Powell said that the inflation rate was nevertheless still too high.
“The process of getting inflation back down to 2% has a long way to go and is likely to be bumpy,” he said.
And so the Fed-sponsored market beatings continue.
🏛️ The Fed also signals right hikes could be coming to an end. While the Fed is currently maintaining a hawkish stance in regards to monetary policy, it also signaled that interest rate hikes could be over. Consider this line from the March 22 FOMC statement (emphasis added):
“The Committee anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time.“
And compare it to the language used in the February 1 FOMC statement (emphasis added):
“The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.“
JPMorgan’s Michael Feroli characterized the change as “less hawkish and less committal.“
“That leaves a hike on the table, but it is less obvious it comes at the next meeting,“ Neil Dutta, head of economics at Renaissance Macro, wrote on Wednesday.
The Fed’s updated Summary of Economic Projections released Wednesday suggested that the central bank saw one more 25 basis point rate hike some time this year before hitting its peak target rate. It’s another sign that the Fed’s campaign of rate hikes could pause and may soon be over.
💳 Consumers seem unaffected by banking turmoil. While credit card data suggests the economy continues to cool, there’s little indication that the recent banking turmoil has had a material effect on spending.
From Bank of America: “Total card spending per [household] fell by 0.4% y/y in the week ending Mar 18 according to [Bank of America] aggregated credit and debit card data. Card spending has been slowing since Jan. At the national level, it has not been clearly impacted by regional banking stress.“
And from JPMorgan (h/t Carl Quintanilla): “Recent bank failures in the US have raised questions about the consequences for consumers. … our Chase consumer card transactions data (credit and debit) through March 19 do not show a meaningful impact on spending in the first week after the event.“
💼 Unemployment claims remain low. Initial claims for unemployment benefits — the most up-to-date of the major labor market stats — fell to 191,000 during the week ending March 18, down from 192,000 the week prior. While the number is up from its six-decade low of 166,000 in March 2022, it remains near levels seen during periods of economic expansion.
For more on low unemployment, read: The labor market is simultaneously hot 🔥, cooling 🧊, and kinda problematic 😵💫.
👍 Businesses are investing. Orders for nondefense capital goods excluding aircraft — a.k.a. core capex or business investment — climbed 0.2% to a near-record $75.2 billion in February.
The backlog of unfilled core capex orders was at $266.9 billion during the month.
For more on this massive economic tailwind, read: 9 reasons to be optimistic about the economy and markets 💪
🏚 Home sales jump. Sales of previously owned homes jumped 14.5% in February to an annualized rate of 4.58 million units. From NAR Chief Economist Lawrence Yun: “Conscious of changing mortgage rates, home buyers are taking advantage of any rate declines. Moreover, we're seeing stronger sales gains in areas where home prices are decreasing and the local economies are adding jobs.“
💸 Home prices are cooling. From the NAR: “The median existing-home price for all housing types in January was $363,000, a decline of 0.2% from February 2022 ($363,700), as prices climbed in the Midwest and South yet waned in the Northeast and West.“
📈 New home sales are up. Sales of newly built homes rose 1.1% in February to an annualized rate of 640,000 units.
👍 Surveys suggest things are getting better. According to the S&P Global Flash U.S. Composite PMI, private sector activity “grew at a solid pace that was the fastest since May 2022 as demand conditions improved and new order growth returned. Manufacturers and service providers alike registered upturns in output, with service sector firms driving the increase.”
With surveys, remember: What businesses do > what businesses say 🙊
📈 Near-term GDP growth estimates remain rosy. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 3.2% rate in Q1. This is up considerably from its initial estimate of 0.7% growth as of January 27.
💸 Stock buybacks are off their highs. According to data from S&P Dow Jones Indices (SPDJI), S&P 500 companies bought back $211.2 billion worth of stock in Q4 2022, up from $210.8 billion in Q3 and down from $270.1 billion in the prior year.
While it’s true that the dollar value of buybacks has generally trended higher over the years, it’s not true that this activity is becoming a growing share of the market. See chart below.
“Buybacks as a percentage of market value decreased to 0.66% in Q4 2022 from 0.70% in Q3 2022 (Q4 2021 was 0.67%); the historical average is 0.65%“ Howard Silverblatt, senior index analyst at SPDJI, wrote in an email on Tuesday.
For more on buybacks, read: The record-high stock buybacks aren't as wild as they seems 🧐
Putting it all together 🤔
Despite recent banking tumult, we’re getting a lot of evidence that we could see a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
The Federal Reserve recently adopted a less hawkish tone, acknowledging on February 1 that “for the first time that the disinflationary process has started.“ And on March 22, the Fed signaled that the end of interest rate hikes is near.
In any case, inflation still has to come down more before the Fed is comfortable with price levels. So we should expect the central bank to keep monetary policy tight, which means we should be prepared for tighter financial conditions (e.g. higher interest rates, tighter lending standards, and lower stock valuations).
All of this means the market beatings may continue for the time being, and the risk the economy sinks into a recession will be relatively elevated. In fact, recession risks intensified recently with bank failures sparking concerns about financial stability.
However, it’s important to remember that while recession risks are elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs. Those with jobs are getting raises. And many still have excess savings to tap into. Indeed, strong spending data confirms this financial resilience. So it’s too early to sound the alarm from a consumption perspective.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have had a pretty rough couple of years, the long-run outlook for stocks remains positive.
For more on how the macro story is evolving, check out the the previous TKer macro crosscurrents »
For more on why this is an unusually unfavorable environment for the stock market, read: The market beatings will continue until inflation improves 🥊 »
For a closer look at where we are and how we got here, read: The complicated mess of the markets and economy, explained 🧩 »
TKer’s best insights about the stock market 📈
Here’s a roundup of some of TKer’s most talked-about paid and free newsletters about the stock market. All of the headlines are hyperlinked to the archived pieces.
10 truths about the stock market 📈
The stock market can be an intimidating place: It’s real money on the line, there’s an overwhelming amount of information, and people have lost fortunes in it very quickly. But it’s also a place where thoughtful investors have long accumulated a lot of wealth. The primary difference between those two outlooks is related to misconceptions about the stock market that can lead people to make poor investment decisions.
Stomach-churning stock market sell-offs are normal🎢
Investors should always be mentally prepared for some big sell-offs in the stock market. It’s part of the deal when you invest in an asset class that is sensitive to the constant flow of good and bad news. Since 1950, the S&P 500 has seen an average annual max drawdown (i.e., the biggest intra-year sell-off) of 14%.
How stocks performed when the yield curve inverted ⚠️
There’ve been lots of talk about the “yield curve inversion,” with media outlets playing up that this bond market phenomenon may be signaling a recession. Admittedly, yield curve inversions have a pretty good track record of being followed by recessions, and recessions usually come with significant market sell-offs. But experts also caution against concluding that inverted yield curves are bulletproof leading indicators.
How the stock market performed around recessions 📉📈
Every recession in history was different. And the range of stock performance around them varied greatly. There are two things worth noting. First, recessions have always been accompanied by a significant drawdown in stock prices. Second, the stock market bottomed and inflected upward long before recessions ended.
In the stock market, time pays ⏳
Since 1928, the S&P 500 generated a positive total return more than 89% of the time over all five-year periods. Those are pretty good odds. When you extend the timeframe to 20 years, you’ll see that there’s never been a period where the S&P 500 didn’t generate a positive return.
700+ reasons why S&P 500 index investing isn't very 'passive'💡
Passive investing is a concept usually associated with buying and holding a fund that tracks an index. And no passive investment strategy has attracted as much attention as buying an S&P 500 index fund. However, the S&P 500 — an index of 500 of the largest U.S. companies — is anything but a static set of 500 stocks. From January 1995 through April 2022, 728 tickers have been added to the S&P 500, while 724 have been removed.
The key driver of stock prices: Earnings💰
For investors, anything you can ever learn about a company matters only if it also tells you something about earnings. That’s because long-term moves in a stock can ultimately be explained by the underlying company’s earnings, expectations for earnings, and uncertainty about those expectations for earnings. Over time, the relationship between stock prices and earnings have a very tight statistical relationship.
When the Fed-sponsored market beatings could end 📈
At some point in the future, we’ll learn a new bull market in stocks has begun. Before we can get there, the Federal Reserve will likely have to take its foot off the neck of financial markets. If history is a guide, then the market should bottom weeks or months before we get that signal from the Fed.
What a strong dollar means for stocks 👑
While a strong dollar may be great news for Americans vacationing abroad and U.S. businesses importing goods from overseas, it’s a headwind for multinational U.S.-based corporations doing business in non-U.S. markets.
Economy ≠ Stock Market 🤷♂️
The stock market sorta reflects the economy. But also, not really. The S&P 500 is more about the manufacture and sale of goods. U.S. GDP is more about providing services.
Stanley Druckenmiller's No. 1 piece of advice for novice investors 🧐
…you don't want to buy them when earnings are great, because what are they doing when their earnings are great? They go out and expand capacity. Three or four years later, there's overcapacity and they're losing money. What about when they're losing money? Well, then they’ve stopped building capacity. So three or four years later, capacity will have shrunk and their profit margins will be way up. So, you always have to sort of imagine the world the way it's going to be in 18 to 24 months as opposed to now. If you buy it now, you're buying into every single fad every single moment. Whereas if you envision the future, you're trying to imagine how that might be reflected differently in security prices.
Peter Lynch made a remarkably prescient market observation in 1994 🎯
Some event will come out of left field, and the market will go down, or the market will go up. Volatility will occur. Markets will continue to have these ups and downs. … Basic corporate profits have grown about 8% a year historically. So, corporate profits double about every nine years. The stock market ought to double about every nine years… The next 500 points, the next 600 points — I don’t know which way they’ll go… They’ll double again in eight or nine years after that. Because profits go up 8% a year, and stocks will follow. That's all there is to it.
Warren Buffett's 'fourth law of motion' 📉
Long ago, Sir Isaac Newton gave us three laws of motion, which were the work of genius. But Sir Isaac’s talents didn’t extend to investing: He lost a bundle in the South Sea Bubble, explaining later, “I can calculate the movement of the stars, but not the madness of men.” If he had not been traumatized by this loss, Sir Isaac might well have gone on to discover the Fourth Law of Motion: For investors as a whole, returns decrease as motion increases.
'Past performance is no guarantee of future results,' charted 📊
S&P Dow Jones Indices found that funds beat their benchmark in a given year are rarely able to continue outperforming in subsequent years. According to their research, 29% of 791 large-cap equity funds that beat the S&P 500 in 2019. Of those funds, 75% beat the benchmark again in 2020. But only 9.1%, or 21 funds, were able to extend that outperformance streak into 2021.
One stat shows how hard it is to pick market-beating stocks 🎲
Picking stocks in an attempt to beat market averages is an incredibly challenging and sometimes money-losing effort. In fact, most professional stock pickers aren’t able to do this on a consistent basis. One of the reasons for this is that most stocks don’t deliver above-average returns. According to S&P Dow Jones Indices, only 22% of the stocks in the S&P 500 outperformed the index itself from 2000 to 2020. Over that period, the S&P 500 gained 322%, while the median stock rose by just 63%.
It seems that banks reacted early on, as of March 10 there was the word out of Credit Suisse being unable to honor payouts. However for the bank J holding the high risk mix of lending tools,it wasn't possible to oversee the maturity of short term bonds and need for liquidity. As mucha as this is unregulated and EU commission reassuring users and investors on safety mechanism, and general agreement on the factor tighter interest rates, the Transcript is talking about mismanagement:-/ for how long would have been financial assessors aware of the inverted curve for interests rates? What about unrealized gains during this period, couldnt it had been overseen?