Note: I have published an updated version of my recent article “Cash Is Interesting Again. And Safe.” to reflect the higher interest being paid on cash accounts starting tomorrow with millions of dollars in insurance by both Flourish (increased to 4.55% for Tier 1 and 4.25% for Tier 2) and Betterment (increased to 4.50%). The updated version of the article can be viewed here.
Markets woke up on Monday morning to the news that First Republic Bank (FRC) had finally been taken behind the woodshed and shot in what is now the new second-largest bank failure in US history, snatching that dubious honor from Silicon Valley Bank (SVB) which now slips to the bronze medal position in that particular contest. FRC was seized by the regulators and JP Morgan Chase (JPM) won the takeover sweepstakes over the weekend.
FRC’s shareholders and bondholders are getting completely wiped out (just as with SVB and Signature Bank), while all of its $104 billion-worth of deposits, whether insured or uninsured, are being protected and back-stopped by JPM as is the way of things these days, it seems. JPM and the Federal Deposit Insurance Corporation (FDIC) will share all the losses and any recoveries from the transaction.
Markets churned sideways on Monday, with investors twiddling their thumbs in advance of Wednesday’s Fed Day before deciding on Tuesday that they maybe weren’t going to like what they were going to hear the next day as well as turning their attention away from the now-resolved FRC saga onto other shaky regional banks. PacWest Bancorp (PACW), First Horizon (FHN) and Western Alliance (WAL) would seem to be the next problem children.
On Wednesday afternoon, the Federal Reserve followed expectations and approved another 0.25% interest rate rise. The decision marked the Fed’s tenth consecutive rate increase without a break aimed at battling inflation and brings its benchmark Federal Funds rate up to a range of between 5.00% and 5.25%, the highest since Beyonce warned us not to think that we were irreplaceable in 2007.
In a hint (but notably not a commitment) that officials could pause rate increases after the latest move, they deleted a phrase from their previous policy statement that had said some additional increases might be appropriate. Instead, officials said in their new statement that they would now monitor economic and financial market developments on an ongoing basis and make future interest rate decisions accordingly on a meeting-by-meeting schedule.
“We’re no longer saying that we anticipate further rate increases”, Fed Chair Jerome Powell said, calling that “a meaningful change.” He did, however, go out of his way to continue to push back against the idea of the imminent interest rate cuts that the market so strongly believes will happen later this year. He also reiterated in response to a question in the press conference the somewhat obvious notion that the Fed’s 2% inflation target (see EXPLAINER: FINANCIAL TERM OF THE WEEK below) will not be satisfied by getting down to a 3% or 4% inflation rate.
This more-cautious-than-anticipated attitude and Powell’s failure to formally anoint a pause in favor of “data dependency” disappointed markets which had been looking for a less nuanced and more celebratory announcement of the final death of interest rate hikes and by the time the press conference ended, stocks had moved quite a bit lower. These concerns continued to trouble investors again on Thursday.
But to all intents and purposes, the Fed has now met the first half of the “hike/pause/pivot/cut” script that has helped prop up stock markets for most of 2023 in the face of some really quite disturbing economic data. So, with the Fed no longer applying pressure to the economy via higher rates, it makes economic growth now the absolute key to whether the next 10%-15% move in stock prices is up or down and it’s the economic data that will tell us which way it’s breaking and it all started with Friday’s US April Jobs Report.
When it came out before the market open, the report blew through all the estimates with a month-to-month increase in payrolls of 253k versus an average expectation of 185k and the previous month’s revised increase of $165k. The unemployment rate unexpectedly fell to a multi-decade low of 3.4%.
A few months back, such a white-hot Jobs Report may have sent stocks crashing on fears of more aggressive Fed rate hiking. But the world is suddenly a different place and now it provides reassurance that the economy still has momentum and is holding up remarkably well. Stocks responded by exploding higher during Friday’s session, also propelled by the long-awaited return of a bit of BTFD after a long absence.
But lurking in the shadows are the twin specters of a deteriorating regional bank situation and the possible debt ceiling shit-show in Congress.
US Treasury Secretary Janet Yellen raised the stakes in the debt ceiling game of chicken on Monday, saying that the US could be in default of its debt obligations within a month if lawmakers persisted with their infuriating and nonsensical partisan posturing (not her exact words, but I’m pretty sure that’s what she meant) and Jerome Powell echoed her concerns in his press conference on Wednesday, calling for an immediate no-drama increase in the debt ceiling.
Bloomberg last week reported estimates that an actual US debt default could lead to the permanent loss of millions of American jobs, crush the stock market by 45% and collapse Gross Domestic Product (GDP) by 6.1%. The Director of US National Intelligence also warned that China and Russia would likely seek to exploit any default by sowing and spreading global doubt about the value of the US Dollar as well as the US’ world leadership role and the sustainability of domestic institutions.
In other words, a debt default would be an absolute catastrophe for the United States that would endure long beyond 2023 and it is completely beyond belief that some in Congress seem willing to risk this to score petty political points.
OTHER NEWS ..
Openings closing .. The latest Job Openings and Labor Turnover Survey (JOLTS) - released just ahead of the Fed rate decision last week - pointed toward a pretty sizable collapse of the labor market. According to the survey, job openings fell for the third consecutive month, down to 9.6 million from a revised 10 million the previous month. This represents a current rate of about 1.6 available jobs per unemployed person. It marks the lowest number of job openings since April 2021, having now declined by more than 20% since the peak reading in March 2022 of over 12 million. However, they still have plenty more to fall before they reach the pre-pandemic levels of around 7.5 million.
And not only are job openings drying up, but layoffs are on the rise as well. According to the report, layoffs rose to 1.8 million, up from a revised 1.6 million a month earlier. This is the highest number of layoffs recorded in a month since December 2020 and certainly dialed up concerns about an upcoming recession.
Taste of his own medicine .. About a quarter of the value of Icahn Enterprises (IEP) was lost in a day on Tuesday and the stock hit a ten year low after research firm Hindenburg Research published a report saying that IEP was overvalued, holding assets at inflated prices and vulnerable to its founder Carl Icahn’s borrowing against its shares; in other words, the kind of mismanagement and malfeasance that Icahn often criticizes others for.
“Icahn has been using money taken in from new investors to pay out dividends to old investors,” Hindenburg wrote in its research note. “Such Ponzi-like economic structures are sustainable only to the extent that new money is willing to risk being the last one 'holding the bag.'"
Known as “The Corporate Raider," Icahn has made this name as an activist investor, buying up stock in companies and then agitating for change. Icahn’s recent activist targets include McDonalds (MCD), Kroger (KR) and Illumina (ILMN). Nathan Anderson-led Hindenburg Research has a track record of calling out fraud and misconduct at publicly-traded companies, most recently at Jack Dorsey-led Block (SQ).
More trouble at Coinbase .. A Coinbase investor filed what amounts to an insider-trading complaint against current and former executives, venture capitalist investors and board members, including CEO Brian Armstrong. The lawsuit alleges that Armstrong, Andreessen Horowitz, co-founder Fred Ehrsam, board members Kathryn Haun and Fred Wilson and other insiders all sold a collective $2.9 billion (!!!) of stock in connection with the direct listing “all the while in possession of material, non-public information.”
Adam Grabski, the investor who filed the lawsuit, bought shares on the day the crypto exchange went public in 2021. Within days, many analysts had already noted that the firm’s heavy reliance on transaction fees was concerning - 96% of Coinbase’s revenue came from transaction fees. Days later, the board apparently met, discussed pricing and made decisions that eventually resulted in the closure of Coinbase Pro, replaced by the lower-fee Coinbase Advanced Trade.
UNDER THE HOOD ..
Right now you can drive a truck through the divergence in performance of Large Cap stocks and Small Cap stocks. Weakness in Small Caps via ever-vanishing investor risk appetite has taken a negative toll on the technical health of the entire investing environment beneath the surface. Remember, all most people see is the headline index performance which mostly reflects the performance of a handful of Super Mega Caps, but it is Small Caps that make up the majority of all stocks. The Percent of Small Cap Stocks Within 2% of Their One Year Highs has fallen from nearly 19% on February 2nd to a reading of barely over 7% on May 1st.
But now the weakness fully manifested in Small Cap stocks is starting to creep into the Mid Cap universe and the S&P 500 appears to be rising on fumes on its up-days. Any sudden surge in Supply will likely be met with insufficient Demand to soak it up and that reflects a market that is even more vulnerable than just weeks ago.
Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.
THIS WEEK’S UPCOMING CALENDAR ..
It will be another busy week of earnings, including from Paypal, Devon Energy, Airbnb, Duke Energy, Occidental Petroleum, Electronic Arts, Tyson Foods, JD.com, Toyota, Honda, Roblox, Trade Desk, Tapestry and KKR.
The big economic highlight of the week comes on Wednesday, when we get to learn the Consumer Price Index (CPI) measure of retail inflation for April. Expectations are for a 5.0% year-over-year increase, matching the March data. The important Core CPI is expected to rise 5.4%.
The next day sees the release of the Producer Price Index (PPI) measure of wholesale inflation experienced by manufacturers for April. This expected to increase by 2.4% year on year with the Core PPI expected to rise 3.3%.
On Friday, the University of Michigan releases its Consumer Sentiment Index for May. Forecasts call for a lower 62.6 reading.
The release of the Federal Reserve’s Senior Loan Officer Opinion Survey (SLOOS) on bank lending practices doesn’t usually make many waves. Its release on Monday this week, however, could provide valuable insight into the future of the economy, showcasing how senior loan officers are operating following the collapse of Silicon Valley Bank and Signature Bank last month.
AVERAGE 30-YEAR FIXED RATE MORTGAGE ..
6.39%
(one week ago: 6.43%, one month ago: 6.65%, one year ago: 5.27%)
Data courtesy of: FRED Economic Data, St. Louis Fed as of Thursday of last week.
US INVESTOR SENTIMENT (outlook for the upcoming 6 months) ..
↑Bullish: 24% (24% a week ago)
↔ Neutral: 31% (37% a week ago)
↓Bearish: 45% (39% a week ago)
Net Bull-Bear spread: ↓Bearish by 21 (Bearish by 15 a week ago)
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.
US TREASURY INTEREST RATE YIELD CURVE ..
The interest rate yield curve remains “inverted” (i.e. most shorter term interest rates are higher than longer term ones) with the highest rate (5.59%) being paid currently for the 1-month duration and the lowest rate (3.41%) for the 7-year.
The closely-watched and most commonly-used comparative measure of the spread between the 2-year and the 10-year last week fell from 0.60% to 0.48%, indicating an overall flattening of the curve over the last five days.
The curve has been inverted since July 2022 based on the 2-year vs. the 10-year spread. Historically, an inverted yield curve has been regarded as a leading indicator of an impending recession, with shorter term risk deemed to be unusually higher than longer term.
Data courtesy of ustreasuryyieldcurve.com as of Friday.
FEDWATCH INTEREST RATE PREDICTION TOOL ..
What are the latest market expectations for what the Fed will announce re: interest rate changes (Fed Funds rate, currently 5.125%) on June 14th after its next meeting?
↓ 0.25% cut .. 7% probability
(one week ago: 11%, one month ago: 54%)
↔ No change .. 93% probability
(one week ago: 65%, one month ago: 37%)
↑ 0.25% increase .. 0% probability
(one week ago: 24%, one month ago: 0%)
Data courtesy of CME FedWatch Tool. Calculated from Federal Funds futures prices as of Friday.
LAST WEEK BY THE NUMBERS ..
Last week’s market color courtesy of finviz.com:
- Last week’s best performing US sector: Technology (two biggest holdings: Apple, Microsoft) - up 0.3% for the week
- Last week’s worst performing US sector: Energy (two biggest holdings: Exxon-Mobil, Chevron) - down 5.7% for the week
- The proprietary Lowry's measure for US Market Buying Power is currently at 139 and fell by 12 points last week and that of US Market Selling Pressure is now at 161 and rose by 11 points over the course of the week.
- SPY, the S&P 500 ETF, remains above its 50-day and 90-day moving averages and above its long term trend line. SPY ended the week 13.7% below its all-time high (01/03/2022).
- QQQ, the NASDAQ-100 ETF, remains above its 50-day and 90-day moving averages and above its long term trend line. QQQ ended the week 20.1% 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 1.4 point higher at 17.2. It remains below its 50-day and 90-day moving averages and below its long term trend line.
ARTICLE OF THE WEEK ..
What to do with your 401k when you change jobs.
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).
The US Federal Reserve's mandate was shaped in the 1970s. This was a period that experienced simultaneous high inflation and unemployment, a condition known as stagflation. Modifying the original act that established the Federal Reserve in 1913, the Federal Reserve Act of 1977 clarified the roles of the Board of Governors and Federal Open Market Committee (FOMC).
Congress explicitly stated the Fed's goals should be "maximum employment, stable prices, and moderate long-term interest rates." It is these goals that came to be known as the Fed's "dual mandate" and remain today. In this article, we explore all three facets of the central bank's mandate by first looking at maximum employment before turning to the other two goals, which can effectively be treated as a single mandate.
Maximum Employment
Maximum employment is also referred to as full employment. It is the total measure of employment that the economy can experience without ushering in overt inflationary pressures. As such, almost everyone who wants a job can secure one during maximum employment. The goal, though, isn't to reach 100% employment and completely eradicate unemployment. That's just not possible.
Economists know there will always be some level of unemployment. People will always quit and start new jobs, businesses will fail and new ones will be set up, and specific sectors will contract and expand. Because it takes time to find a new job, there will always be a certain level of unemployment. As such, the level the Fed is tasked with achieving is not 0% unemployment.
The desired unemployment level is one that prevails in normal economic conditions or in the absence of a boom or recession. This rate is commonly referred to as the non-cyclical rate of unemployment—previously called the natural rate of unemployment). It is determined by structural factors that affect the flexibility or mobility of the labor market. For example, regulations that restrict labor mobility tend to raise the natural rate. But allowing individuals mobility to work in other regions can effectively reduce the natural rate of unemployment.
Stable Prices and Moderate Long-Term Interest Rates
People and businesses need to be reasonably confident that prices will remain relatively constant over time so they can make plans for the future. As a result, price instability in the form of either deflation or rapid inflation can have drastic consequences on economic stability.
As noted above, ensuring stable prices and moderate long-term interest rates could effectively be interpreted as a single mandate. That's because long-term nominal interest rates are set with inflation expectations in mind. For any given nominal interest rate, rapidly rising prices diminish the real interest rate that lenders receive and debtors must pay. Thus, in an unstable monetary environment with rapidly rising prices, lenders will want to charge much higher interest rates to mitigate the inflation-rate risk.
The FOMC began targeting inflation at 2% in January 2012 in order to achieve its dual mandate. This was just after combining the goals of stable prices and moderate long-term interest rates into a single one. As such, many see this as the Fed's attempt to be consistent with the single mandate of price stability sought by the European Central Bank (ECB).
By ensuring price stability, the Fed reasons that this inflationary target creates a stable economic environment that can foster the goal of maximum employment. When prices are stable, people and businesses can make longer-term economic decisions necessary for stable economic growth. This leads to improved employment opportunities.
The Bottom Line
Whether it is a triple, dual or single mandate, the primary aim of the Federal Reserve is to create a stable monetary environment. To achieve this, the Fed has deemed that targeting inflation (by keeping it at a low and stable rate of near 2%) is the best way to achieve such stability. So all the fuss about changing interest rates is really all about keeping prices stable in order to foster economic growth and promote maximum employment.
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