A decent gain in stock prices on Monday was put down to a combination of an oversold bounce from the anguish of the two prior sessions, UBS finally putting Credit Suisse (CS) out of its misery by buying their Swiss banking rival for less than half of its value as well as not-too-guarded optimism about what Federal Reserve Chair Jerome Powell might say in his press conference later in the week, specifically speculating that he might formally announce that the rate-hiking cycle was over.
Concerns about First Republic Bank (FRC) just refused to go away. Despite stories of an orchestrated rescue by other banks and special treatment from regulators, the stock fell to below 10% of its value from earlier this month. That is danger territory.
By Tuesday night, the markets had pretty much decided that a quarter of a point rate hike was going to happen the next day (87% probability) and the Federal Reserve duly delivered, approving that exact interest rate increase in its 2pm announcement. It signaled (but did not guarantee) that we may be almost there when it finally comes to the end of year-long interest rate-rise campaign.
The decision marked the Fed’s ninth consecutive rate increase without a break and brings the benchmark Federal Funds Rate to 4.875%, the highest level since the Plain White T’s tried to get Delilah’s attention back in 2007.
The Fed also released its quarterly “Dot Plot” which maps out the policymakers' expectations for where they think interest rates will go in the future. This suggested that the Fed committee members see rates peaking at 5.1% this year, implying that there will be just one more quarter-point hike before the long-awaited pause.
The committee members’ expectations are that interest rates will be lower at 4.1% at the end of 2024 and down to 3.1% at the end of 2025. However, Powell said during his press conference that a rate cut in 2023 was “not a part of our baseline expectation”.
The market, however, doesn’t believe a word of it and the futures are currently pricing the probability of interest rates being lower at the end of this year than they are now as a 100% certainty (see FEDWATCH TOOL, below).
The market reaction to the Fed announcement was one of disappointment. A radical change from the Fed in the face of this bank stress had been aggressively priced in to stocks already and it didn’t happen. Instead we were treated to a rather uninspiring and, frankly, dull response from a seemingly unruffled Fed, with Powell even dismissing the collapse of Silicon Valley Bank as “an outlier” in an otherwise-”sound banking system”.
And so, for about the zillionth time in the last year, the stock market was again burned by its over-optimism and exuberance about what was going to happen with interest rates.
To make matters worse; while JP was speaking to the press, Treasury Secretary Janet Yellen was asked at a Senate hearing if the Treasury was looking at taking steps to swiftly expand bank account deposit insurance in the light of recent events."This is not something that we have looked at. It's not something that we are considering," she said during what was an uncharacteristically nervous performance. Following these rather clumsy comments, a moderate stock selloff that had been kicked off by frustration with the Fed accelerated into a full-blown price slump late in the afternoon.
Yellen somewhat walked back her remarks on Thursday but stocks, clearly still jittery about the banks, responded by just churning aimlessly up and down on high volume, a strong indication of market indecision and lack of conviction in either direction.
On Friday morning, Germany’s prestigious Deutsche Bank moved into the limelight as the price of their credit default swaps (basically the insurance premium against the bank going out of business, see EXPLAINER: FINANCIAL TERM OF THE WEEK below) rocketed on fears of the size and nature of their exposure to recently troubled institutions.
Management and German government officials were hastily rushed out to say that there were no problems, which of course is a sure sign that there are problems. Markets initially fell quite hard on the news but recovered later to finish the day - and the week - moderately in the green.
What will determine the next 10%-20% move in the S&P 500 isn’t when or even if the Fed hikes interest rates by another 0.25%, but instead whether we get a hard or soft economic landing.
The Fed acknowledged that the banking crisis is likely not helpful when it comes to this outcome, given the important role that regional banks play in the very existence of countless small businesses throughout the country and the possible reduction in the availability of credit to these companies.
To put it bluntly, if the reason that the Fed is ending rate hikes is because economic risks are now highly elevated, then that’s not a reason to buy stocks.
So upcoming economic data remains the absolute key. If the data rolls over in the next month or two indicating a rapid and sharp loss of economic momentum, we should expect material downside in stock markets, with the October 2022 lows and beyond very much under threat.
I’ll be keeping an eye on it for you.
OTHER NEWS ..
Another tech bro bites the dust? .. Hindenburg Research is a forensic financial research firm that specializes in exposing fraud, accounting irregularities, bad actors, unethical practices, compliance wrongdoing and undisclosed transactions by companies from around the world. It then shorts that company’s stock right as it publishes a report. It has in the past exposed misconduct, information-suppression and/or outright fraud and corruption at, among others, Nikola, Draft Kings, Tether, Adani and Clover Health.
The subject of Hindenberg’s latest report is Block (SQ), whose shares plunged last week after allegations of massive fraud and corruption at the mobile payments provider co-founded by one of the ultimate tech bro pin-ups and annoying libertarian hippie, Jack Dorsey.
Block is tailored to small and medium-sized businesses and individuals with limited access to banking services. The company’s signature apps include Square (the original name of the firm and origin of the SQ ticker symbol) which accepts credit card payments and Cash App, which allows individual users to transfer money.
After a two-year investigation of the company’s practices, Hindenburg concluded that, primarily based on information received from former employees, somewhere up to 75% of Block accounts are either fake, used to commit fraud and/or are duplicate accounts tied to just one person.
Block’s initial success came not from disruptive innovation, but from its “willingness to facilitate fraud against consumers and the government, avoid regulation, dress up predatory loans and fees as ‘revolutionary technology’ and mislead investors with inflated metrics.”
According to the report, Block also skirted regulatory requirements in what it has described as a “Wild West” approach to compliance, fully enabling “bad actors to mass-create accounts for identity fraud and other scams” .
Hindenberg Research additionally revealed that co-founders Dorsey and James McKelvey collectively sold over $1 billion of the stock as the price rocketed during the pandemic before embarking on an epic 80% crash in October 2021. The company was also apparently guilty of deliberately misappropriating (otherwise known as stealing from the taxpayer) COVID relief funds by knowingly using the fake, fraudulent and duplicate accounts as a basis for the Federal handouts.
Not a good week for celeb crypto shillers .. Lindsay Lohan, Jake Paul, Soulja Boy, Lil Yachty, Austin Mahone, Kenda Lust, Neo-Yo and Akon were all charged by the Securities and Exchange Commission (SEC) with illegally touting Justin Sun’s broken crypto coins Tronix (TRX) and BitTorrent (BTT) and failing to disclose that they were paid to do so. Only Soulja Boy and Austin Mahone even bothered to dispute the charges, the rest all settled with authorities right away.
And good news from Montenegro, where fugitive con-man Do Kwon, the uber-crypto-bro behind the Terra/Luna scam that wiped out an estimated $40 billion from crypto markets and who famously asserted “I don’t debate the poor” in response to concerns raised about his fraudulent blockchain platform, was finally arrested after months on the run. The US, Singapore and South Korea will now fight it out to determine who provides him with a jail cell for what will likely be a lengthy stretch inside.
Real estate: starting to unfreeze? .. Sales of previously-owned homes rose 14.5% in February compared with January. It was the first monthly gain in twelve months and the largest increase since July 2020, right after the start of the COVID pandemic. However, sales were still 22.6% lower than they were in February 2022.
The median price of an existing home sold in the US in February was $363k, a 0.2% decline from February 2022. This marks the first monthly year-over-year price decline since Tottenham’s finest, Adele, first defied physics and set fire to rain in 2012.
Regionally, prices fell more from a year ago in the West (down 5.6%) and Northeast (down 4.5%), where housing is more expensive. But prices were still climbing from last year in the South (up 2.7%) and the Midwest (up 5%).
UNDER THE HOOD ..
From a technical standpoint the market is in a holding pattern, albeit with a negative bias. Participation and volume on the rally days has recently been surpassed by participation and volume on the declining days, which is not consistent with a renewed advance.
It seems that the market has not sorted out what it wants to do just yet. Prices are right in the middle of a wide range that can be traced back over a year, a kind of technical “no man’s land” . When this is the case, the immediate risk/reward profile is generally not very favorable.
Another measure of investor attitude toward risk can be found in the relative performances of the Mid Cap and Small Cap indexes. Since the early February market high, the relative strength for both indexes collapsed vs. Large Cap, reflecting a severe reduction in the willingness to take on the higher risk associated with these smaller stocks.
Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.
THIS WEEK’S UPCOMING CALENDAR ..
Data on the U.S. consumer and housing market, congressional testimony plus a few remaining earnings reports and an investor event will be this week's highlights.
Economic data highlights of the week include Tuesday's Consumer Confidence Index for March and the Personal Income and Expenditures report for February. Housing market data out next week includes the latest Case-Shiller national Home Price Index and Pending Home Sales Index.
On Wednesday, the Federal Reserve Vice Chair for Supervision Michael Barr and Federal Deposit Insurance Corporation (FDIC) Chairman Martin Gruenberg are scheduled to testify before the House Financial Services Committee where they will likely face a grilling on the collapses of Silicon Valley Bank and Signature Bank and efforts to maintain confidence in the US banking system.
Earnings reports this week include Walgreens, BioNTech, Lululemon Athletica, Paychex, Micron, Cintas and Carnival. Intel will host an investor event.
AVERAGE 30-YEAR FIXED RATE MORTGAGE ..
6.42%
(one week ago: 6.60%, one month ago: 6.13%, one year ago: 4.42%)
Weekly data courtesy of: FRED Economic Data, St. Louis Fed as of Thursday of last week.
US INVESTOR SENTIMENT LAST WEEK (outlook for the upcoming 6 months) ..
↑Bullish: 21% (19% a week ago)
↔ Neutral: 30% (32% a week ago) ↔
↓Bearish: 49% (49% a week ago)
Net Bull-Bear spread .. ↓Bearish by 28 (Bearish by 30 a week ago)
Weekly data courtesy of: American Association of Individual Investors (AAII).
For context: Long term averages: Bullish: 38% — Neutral: 32% — Bearish: 30% — Net Bull-Bear spread: Bullish by 8
Weekly sentiment survey participants are usually polled on Tuesdays and/or Wednesdays.
FEDWATCH TOOL ..
What are the latest market expectations for what the Fed will announce re: interest rate changes (Fed Funds rate) on May 3rd after its next meeting?
↔ No change .. 80%
(one week ago: 54%, one month ago: 0%)
↑ 0.25% increase .. 20%
(one week ago: 21%, one month ago: 70%)
How does the market view the probability that interest rates (Fed Funds rate, currently 4.875%) will be at/above (≥) the following rates at year-end?
≥ 3.50% .. 97%
(one week ago: 90%, one month ago: 100%)
≥ 3.75% .. 78%
(one week ago: 67%, one month ago: 100%)
≥ 4.00% .. 38%
(one week ago: 34%, one month ago: 100%)
≥ 4.25% .. 10%
(one week ago: 10%, one month ago: 100%)
Data courtesy of CME FedWatch Tool. Calculated from Federal Funds futures prices as of market close on Friday.
LAST WEEK BY THE NUMBERS ..
Last week’s market color courtesy of finviz.com:
- Last week’s best performing US sector: Communications Services (two biggest holdings: Alphabet/Google, Meta/Facebook) - up 3.0% for the week
- Last week’s worst performing US sector: Utilities (two biggest holdings: NextEra Energy, Southern Co.) - down 1.6% for the week
- The proprietary Lowry's measure for US Market Buying Power is currently at 152 and rose by 10 points last week and that of US Market Selling Pressure is still at 169 and was unchanged over the course of the week.
- SPY, the S&P 500 ETF, is right at its 50-day moving average and above its 90-day and its long term trend line. SPY ended the week 14.3% below its all-time high (01/03/2022).
- QQQ, the NASDAQ-100 ETF, is now way above its 50-day and 90-day moving averages and its long term trend line. QQQ ended the week 16.3% below its all-time high (11/19/2021).
- VIX, the commonly-accepted measure of anticipated stock market risk and volatility (often referred to as the “fear index”), implied by S&P 500 index option trading, ended the week 3.8 lower at 21.7. It remains just above its 50-day moving average, but is now below its 90-day and its long term trend line.
ARTICLE OF THE WEEK ..
Stock markets are completely unpredictable, especially over shorter spans. Yet you wouldn’t know that from how many people approach investing, where “good” investments are simply defined as those that just make intuitive sense to them at the time. Maybe you should stop trying to make sense of things.
EXPLAINER: FINANCIAL TERM OF THE WEEK ..
A weekly feature using information found on Investopedia to try to help explain Wall Street gobbledygook (may be edited at times for clarity).
A credit default swap (CDS) is a financial derivative that allows an investor to swap or offset their credit risk with that of another investor. To swap the risk of default, the lender buys a CDS from another investor who agrees to reimburse them if the borrower defaults.
Most CDS contracts are maintained via an ongoing premium payment similar to the regular premiums due on an insurance policy. A lender who is worried about a borrower defaulting on a loan often uses a CDS to offset or swap that risk.
A credit default swap is a derivative contract that transfers the credit exposure of fixed income products. It may involve bonds or forms of securitized debt—derivatives of loans sold to investors.
For example, suppose a company sells a bond with a $100 face value and a 10-year maturity to an investor. The company might agree to pay back the $100 at the end of the 10-year period with regular interest payments throughout the bond's life.
Because the debt issuer cannot guarantee that it will be able to repay the premium, the investor assumes the risk. The debt buyer can purchase a CDS to transfer the risk to another investor, who agrees to pay them in the event the debt issuer defaults on its obligation.
Debt securities often have longer terms to maturity, making it harder for investors to estimate the investment risk. For instance, a mortgage can have terms of 30 years. There is no way to tell whether the borrower will be able to continue making payments that long.
That's why these contracts are a popular way to manage risk. The CDS buyer pays the CDS seller until the contract's maturity date. In return, the CDS seller agrees that it will pay the CDS buyer the security's value as well as all interest payments that would have been paid between that time and the maturity date if there is a credit event.
The credit event is a trigger that causes the CDS buyer to settle the contract. Credit events are agreed upon when the CDS is purchased and are part of the contract. The majority of single-name CDSs are traded with the following credit events as triggers:
Reference entity default other than failure to pay: An event where the issuing entity defaults for a reason that is not a failure to pay
Failure to pay: The reference entity fails to make payments
Obligation acceleration: When contract obligations are moved, such as when the issuer needs to pay debts earlier than anticipated
Repudiation: A dispute in the contract validity
Moratorium: A suspension of the contract until the issues that led to the suspension are resolved
Obligation restructuring: When the underlying loans are restructured
Government intervention: Actions taken by the government that affect the contract
CDSs are regulated by the Securities and Exchange Commission and the Commodity Futures Trading Commission under the Dodd-Frank Act.
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