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The charts and themes from the past week that tell an interesting story in markets and investing…
1) The Last Hike?
As widely expected, the Fed hiked rates by another 25 bps last week, the 9th rate hike since last March. That brought the Fed Funds Rate up to a new range of 4.75-5.00%, a level we haven’t seen since September 2007.
All of the focus, though, was on the dovish shift in language from the Fed. Most notably, they removed the text signaling “ongoing increases” in the Fed Funds Rate and replaced it with “some additional policy firming may be appropriate.” Additionally, they argued that the fallout from the recent bank failures would likely “result in tighter credit conditions.”
The market’s interpretation: this was perhaps the last Fed hike of the cycle. Indeed, Fed Funds Futures are now anticipating a pause at the next FOMC meeting (May 3), followed by a rate-cutting cycle starting at some point this summer.
Whether or not this actually happens will be dependent on a number of factors, including a) the path of inflation, b) whether the banking crisis deepens, and c) the state of the US economy.
2) Room to Pause
In looking at the recent inflation data, the Fed seems to finally have room to pause.
Importantly, the Fed Funds Rate is now above Core PCE (the Fed’s preferred measure of inflation), suggesting that monetary policy is now entering a contractionary stage.
While the Fed Funds Rate remains below overall inflation (CPI), that will likely change in the coming months. February’s 6.0% CPI reading was the 8th consecutive decline in the YoY rate of inflation and the lowest level since September 2021. All signs are pointing to a another big move lower in March.
Most of the major CPI categories have shown significant improvement since the inflation peak last June with Shelter being the most notable exception.
Shelter CPI moved up to 8.1% in February, the highest rate of housing inflation we’ve seen since 1982. But remember, Shelter CPI is a lagging indicator. With actual rents and home prices moving lower, it’s only a matter of time before Shelter CPI stops going up. And given its huge weighting in the index (34%), when it does moderate, we’ll see a major impact in overall CPI.
Elsewhere on the inflation front, the data continues to improve. US Import prices were actually down 1% over the last year, the largest YoY decline since September 2020.
And Producer Prices (PPI) increased 4.6% over the last year, the smallest YoY increase since March 2021.
3) The “Fed Put” Is Back
A second reason to believe a pause by the Fed may be coming is the continued stress in the banking system.
The recent 28% two-week decline in the regional bank ETF ($KRE) was the second largest ever, trailing only March 2020 (covid crash). If we look at the other large declines in the table below, they were all associated with significant Fed easing measures.
And what is the Fed doing today?
For starters, they’ve opened up the discount window, with banks borrowing over $150 billion in a single week. That blew past the previous record of $112 billion during the 2008 financial crisis.
The Fed’s balance sheet has grown $392 billion over the last 2 weeks, the largest 2-week spike higher since April 2020. Thus over 60% of the Quantitative Tightening since last April has been undone … in just two weeks.
While the current expansion of the balance is different than prior rounds of QE when the Fed was purchasing bonds, the desired signaling effect is the same: if prices fall too much, too fast, the Fed will step in with massive amounts of liquidity to save the day.
Will it be enough? That remains to be seen, but the market seems to be betting that it won’t, pricing in significant rate cuts over the next two years (to 3% by the end of 2024).
4) The Steepening Signal
Which brings us to the third reason for a potential pause: the economy.
The inverted yield curve has been warning of a contraction for some time, but the massive steepening we’ve witnessed of late is something you typically see around recessions.
On March 8, the spread between the 10-year and 2-year Treasury yields hit -1.07%, the most inverted yield curve since September 1981. 7 trading days later the spread narrowed to -0.42%, a 65 bps increase. This was the biggest 7-day steepening we’ve seen since the 2001 recession.
How did that happen? A dramatic plunge in shorter-term rates. The 2-year Treasury yield moved from 5.05% down to 3.81% in just 7 trading days, which was the largest 7-day decline in yields (-124 bps) since October 19-28 in 1987 (Black Monday crash was on October 19).
During the last 6 US recessions, we saw the Yield Curve (10s minus 2s) steepen aggressively as the Fed entered a rate cutting cycle, pushing short-term rates back below longer-term rates.
The YoY growth rate in the Leading Economic Index fell further into negative territory in February and is at levels that have signaled a recession in the past (2020, 2008, and 2001)…
After adjusting for inflation, one could make a compelling case that the economic slowdown has already begun. Real retail sales declined 1.8% over the last year, the 6th consecutive YoY decline.
And the housing market downturn is evident everywhere you look, with the median price of an existing home turning negative on a YoY basis for the first time since 2012.
5) Blood in the Streets
With downturns and crises come opportunities, and it’s been a while since we’ve seen distressed opportunities at a large scale.
But the events of the past few weeks changed that in a hurry. The combined assets of the SVB and Signature bank failures totaled $319 billion, which was significantly higher than the combined assets of the 371 US bank failures from 2010 through 2022 ($168 billion).
There’s an old saying that “the time to buy is when there’s blood in the streets.”
Judging by the reaction to the asset sales of Signature and Silicon Valley Bank, the market seems to agree.
Shares of New York Community Bank (purchased some of Signature’s assets) and First Citizens BancShares (purchased some of SVB’s assets) both surged higher after the transactions were reported.
And the fire sale of Credit Suisse to its longtime rival saw an initial jump higher in UBS stock.
Will there be more opportunities like this in the coming months?
It certainly seems likely.
Many are saying First Republic Bank ($FRC) will be the next shoe to drop. This despite liquidity injections from the Federal Reserve and JPMorgan, and 11 major US banks trying to instill confidence by depositing a total of $30 billion at First Republic.
My question: if a too-big-to-fail bank puts a few billion into a smaller regional bank that typically would be allowed to fail does that smaller bank then become too-big-to-fail because its failure might trigger a potential failure at the too-big-to-fail bank which by definition can’t fail? My guess is yes, but until that’s explicitly stated we don’t know for sure.
At its IPO in December 2010, First Republic stock priced at $25.50. From there it had over a decade of significant gains, peaking at $222 per share in November 2021. Last week it hit an all-time low of $12, down over 95% from its peak.
6) Deflation in Household Net Worth
The Net Worth of US households fell $4.1 trillion in 2022, the second largest decline on record after 2008. This not an insignificant drop, but what happened before 2022 is important to note. We had three consecutive years of record increases in net worth from 2019-2021, with home prices and stock prices surging higher. The cumulative increases in those three years: $45.9 trillion.
7) Paper Hands
During the 2021 mania Bed Bath had become one of the meme stock favorites in which so-called “diamond hands” were saying they would never sell. Spoiler alert: many did indeed sell, as the company reported one quarter after another of net losses ($1.3 billion in total over the last 4 quarters).
At its IPO in June 1992, Bed Bath & Beyond had a market cap of $288 million. Twenty years later its market cap would peak at $17.4 billion. But it’s been all downhill from there, with its market cap now below $100 million, a 99.5% decline.
8) The Odds Are Not in Your Favor
S&P Dow Jones has released their updated scorecard on active mutual funds.
What did it show? That the odds of picking an active fund that outperforms its benchmark over long periods of time is extremely low, similar to finding a needle in a haystack.
As Jack Bogle once said: “Don’t look for the needle in the haystack. Just buy the haystack.”
9) Why You Diversify
Employees at Silicon Valley Bank ($SIVB) received large amounts of stock compensation over the last decade, with record increases in recent years.
Only a year ago, they likely assumed they had hit the jackpot, with $SIVB stock far outpacing the S&P 500 over the last decade. Few of these employees would’ve believed that all of these holdings were at risk of a complete loss. But fast forward to today and that’s exactly what has happened ($SIVB equity holders are unlikely to receive anything after bankruptcy).
You diversify precisely because of this idiosyncratic type of risk, one that seems impossibly small before it occurs.
(10) A Little Help From Commodities
The S&P GSCI Commodity Index is down 37% from its peak in March 2022, at its lowest level since December 2021. The year-over-year decline of 25% is the largest since May 2020.
We should see a big impact from this move lower in the March CPI report, with most commodity prices now down year-over-year and below the rate of inflation.
This is a huge difference from last March when nearly all commodities were up significantly and rising faster than the overall rate of inflation.
And that’s it for this week. Have a great week everyone!
-Charlie
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