February delivered a reality check to investors after a giddy January; the S&P 500 fell 2.6% for the month and the NASDAQ dropped 1.1%.
Stock and bond prices had risen impressively in January on the ideas that i) Inflation was declining, ie., disinflation, ii) the Fed was almost done with rate hikes and iii) there wasn’t going be a hard economic landing (ie., we were going to get inflation conquered without a recession). At least two of those three ideas are now pretty much considered off the table right now as a result of the data of the past three weeks. That’s why stocks gave back more than half of 2023’s gains.
Since the start of this interest rate hiking cycle a year ago, the market has proved to be consistently over-enthusiastic in pricing in an end to Fed rate rises, taking any hint of a drop in inflation or slowing growth and extrapolating it out to be some catalyst that will cause the Fed to back off.
That expectation has been proved wrong every single time so far and my default position is to remain rather skeptical of these rallies (even if the stock market isn’t) until we see more tangible progress on persistent disinflation, a gently cooling economy and - most importantly - a clear and believable expression from the Fed that an end to interest rate increases is imminent. We certainly aren’t there yet.
Analyst talk last week revolved around the often-dangerous idea of TTID (“This Time It’s Different”). The thinking goes that the consequences of the COVID pandemic permanently transformed the economic landscape and that the Fed may be applying olden timey rules to a new, altered economy by assuming that it could accomplish all it wants simply by raising interest rates to beat off inflation. This is what has caused the professional forecasting community to be almost continually wrong since the beginning of 2020 about the the path of the US economy, the level and duration of inflation and the direction of interest rate policy.
For example, the TTID narrative goes, the vast majority of existing homeowners aren’t going to change their spending (and therefore their contribution to the inflation rate) as the Fed raises interest rates, since they have a 30-year fixed mortgage, likely refinanced around 3% or less and don’t care what a new mortgage costs. Many households have been flush with COVID stimulus money and did not necessarily respond as the dusty old economic textbooks from the 1950s say they should have done to a rising rate environment.
If the TTID truthers are correct, it could be that in order to accomplish their stated goal of bringing inflation back down towards 2% again, recent economic strength and these new debt dynamics could mean the Fed has to work even harder, tightening policy even more harshly and for longer at a level that is absolutely not yet priced in to stocks with the S&P 500 around 4000.
Having said all that, markets ended last week higher as focus shifted temporarily at least from inflation and interest rate concerns to corporate news and earnings reports, which were mixed but generally on the positive side.
Target (TGT) reported better-than-expected earnings, but future guidance was set lower. The retail firm, considered a good proxy for the retail sector as a whole, provided a bright outlook for the overall industry as it said that inventory issues were improving, contracting 3% year-over-year in Q4 2022. However, it also reiterated that the environment remains challenging and that pre-pandemic operating margins are not likely to be recognized before fiscal year 2024 at the earliest.
Last week’s Fed-speak was a little confusing and contradictory. Federal Reserve Bank of Boston President Susan Collins said interest rates must move quickly higher and remain restrictive for some time to bring inflation growth back under control. But at the same time, Federal Reserve Bank of Atlanta President Raphael Bostic said he favors using smaller interest rate adjustments (read: 0.25% at a time) to fine-tune monetary policy and thinks rate hikes could well pause by mid-summer.
Nevertheless, the futures market is showing a quite extraordinary about-turn in professional sentiment about what is going to happen to interest rates (see FEDWATCH TOOL, below) and it doesn’t make pleasant reading for those who like to roll the dice on owning low/no-profit young tech or communications sector growth names for whom higher interest rates are kryptonite.
The odds of a half-percent hike instead of a quarter at the next Fed meeting later this month continue to rise, now reaching 31%, from literally 0% a month ago. Fedwatch also shows that there is basically no-one left who thinks interest rates will be below 5% at the end of the year compared to a 90% perceived chance of this just a month ago.
The probability of rates being at or above 5.25% on New Year’s Eve 2023 is now almost 70%. A month ago, that probability was priced at less than 1%.
OTHER NEWS ..
Closing the Silvergate? .. Incredible scenes last week at the top crypto bank Silvergate (SI), the biggest platform used by cryptocurrency holders to make transfers, which said it was “postponing” the release of its latest annual report and admitted that it was under multiple investigations by the Justice Department. As a result, key partners like Coinbase, Galaxy, Paxos and other crypto firms (hardly Hall of Famers themselves when it comes to good behavior, stability and transparency) decided to stop accepting or initiating Silvergate payments.
The share price plummeted 60% on Thursday alone to a record low of below $6.00 (that’s down over 97% from the high it made near the end of 2021) after the company essentially questioned its own viability, pretty much waving the white flag.
Silvergate reported a $1 billion loss for Q4 2022 and said it expects to record massive further losses related to its securities portfolio after selling additional debt to cover withdrawals. The bank still holds more than $11 billion of client money.
Short sellers and analysts have been banging on for ages about the enormous risks associated with almost all of Silvergate’s client base being unregulated entities, often incompetently run and exposed recently in many cases as being involved in fraud and criminal activity. The rest of the world seems to have finally caught up.
Analysts all over Wall Street slashed their ratings on Silvergate and Morgan Stanley, which had had a sell rating on the stock, even removed its price target entirely, citing the “high level of uncertainty” around the firm.
This looks like an old-fashioned “run on the bank” (see EXPLAINER: FINANCIAL TERM OF THE WEEK, below) and these always end in tears.
This was accompanied by worrying concerns about Tether expressed in a Wall Street Journal exposé last week and on the back of release of the fascinating investigative podcast, Real Money. Tether is the company behind the largest crypto “stablecoin” that claims (without a great deal of verifiable evidence, it would seem) to hold enough funds to be able to maintain a one-for-one peg to a proper currency such as the US Dollar or the Euro in order to facilitate the buying and selling of cryptocurrencies like Bitcoin, Ethereum and the rest.
The whole crypto eco-system feels distinctly unstable right now.
Still falling .. Home prices fell at the end of 2022 as high mortgage rates and concerns about the economy impacted the real estate market. The National Home Price Index showed home prices fell 0.3% in December after seasonal adjustment, and were up 5.8% from a year ago. It was the sixth consecutive month of declines, putting the index 4.4% below its June peak. Prices dropped in all of the 20 cities analyzed by S&P, falling by a median of 1.1%.
On an annualized basis, the cities with the biggest price gains are Miami (+15.9%), Tampa (+13.9%), and Atlanta (+10.4%). Prices fell over the last twelve months in San Francisco (-4.2%) and Seattle (-1.8%).
Mortgage rates rose for the fourth week in a row, dampening the optimism from earlier this year that housing affordability was improving. The average rate on a 30-year, fixed-rate conforming home loan (up to $726,200) was 6.65%, up from 6.5% last week and the highest it's been since early November. Buyers of a median-priced home now have a $2,132 average monthly mortgage payment, a 49% jump from last year.
Entering 2023, borrowing costs decreased with expectations of slower economic growth, lower inflation and easing of Fed monetary policy. However, those haven't happened, and mortgage rates have reversed course. The lower rates in January had brought some buyers back into the market, but that effect already seems to be wearing off.
UNDER THE HOOD ..
A break below 3900 in the S&P 500 would see the index have bearishly crossed five of the seven most widely followed momentum signal levels. That's a lot of jargon to explain that the chart is saying that there's likely to be more downside in store for the S&P 500 if it falls below roughly 3900. Although it closed on Friday at 4045, the index was as low as 3951 at one point last week.
With the obstacle of the overbought conditions lingering from the strong stock market advance early in the year now pretty much dissipated, the ball is back in the court of the buyers. The recent pullback was orderly enough not to significantly damage all of the improved medium and long term technical indicators which pointed to further price gains, but we need to closely watch what happens from here.
An example is the important key indicator of the Percent of Stocks Above Their 30 Week Moving Averages, which is still above the important 75% level that is consistent with a bullish long term stance, but only just.
The recent upward trend line in Lowry’s Buying Power (see LAST WEEK BY THE NUMBERS, below) was broken last week and the recent downward trend line in Selling Pressure is also no longer in place. This is a cause for concern for the bulls.
Continued or accelerating market deterioration would begin to further chip away at these positive indicators and push the technical narrative to what happened in January as being no more than yet another failed fake rally in the midst of a continuing bear market.
Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.
THIS WEEK’S UPCOMING CALENDAR ..
The latest data on the U.S. job market and a few more Q4 2022 earning reports will be next week's highlights.
On Wednesday, the Bureau of Labor Statistics will release the Job Openings and Labor Turnover Survey (JOLTS). The consensus estimate is for 10.7 million job openings on the last business day of January, which would be a slight decline from December.
On Friday, we get the important February Jobs Report. The expectation is for a gain of 215k jobs and for the unemployment rate to hold steady at 3.4%. Last time out, the new jobs numbers surprised massively to the upside, causing a major shift in market sentiment that set the tone for the whole of what was a mostly dismal February.
Companies reporting next week will include Oracle, Crowdstrike, Ciena, Dick’s Sporting Goods, Campbell Soup, JD.com and Ulta Beauty.
General Electric will host an investor day on Thursday and Apple will hold its annual shareholders’ meeting on Friday.
US INVESTOR SENTIMENT LAST WEEK (outlook for the upcoming 6 months) ..
↑Bullish: 23% (21% a week ago)
→Neutral: 32% (40% a week ago)
↓Bearish: 45% (39% a week ago)
Net Bull-Bear spread .. ↓Bearish by 22 (Bearish by 18 a week ago)
Source: American Association of Individual Investors (AAII).
For context: Long term averages: Bullish: 38% — Neutral: 32% — Bearish: 30% — Net Bull-Bear spread: Bullish by 8
The highest recorded percentage of AAII bearish sentiment was 70% and occurred on March 5th 2009, right near the end of the Great Financial Crisis. The lowest percentage of AAII bears was recorded at 6% on August 21st 1987, not long before the stock market crash of October 1987.
Weekly sentiment survey participants are usually polled on Tuesdays and/or Wednesdays.
FEDWATCH TOOL ..
Data courtesy of CME FedWatch Tool. Calculated from Federal Funds futures prices as of market close on Friday:
How does the market view the probability that interest rates (Fed Funds rate, currently 4.625%) will be at/above or below 5.25% at year-end?
At/above 69%-31% Below
(one week ago: 63%-37%, one month ago: 1%-99%)
What are the latest market expectations for what the Fed will announce re: interest rate changes (Fed Funds rate) on March 22nd after their next meeting?
0% probability of no change
(one week ago: 0%, one month ago: 3%)
69% probability of a 0.25% increase
(one week ago: 73%, one month ago: 97%)
31% probability of a 0.50% increase
(one week ago: 27%, one month ago: 0%)
LAST WEEK BY THE NUMBERS ..
Last week’s market color courtesy of finviz.com:
- Last week’s best performing US sector: Materials (two biggest holdings: Linde, Air Products & Chemicals) - up 4.20% for the week
- Last week’s worst performing US sector: Consumer Defensive (two biggest holdings: Proctor & Gamble, Pepsico) - down 0.3% for the week
- The NASDAQ-100 outperformed the S&P 500
- Emerging Markets and Foreign Developed Markets had a better week than US Markets
- Large Caps, Small Caps and Mid Caps all did about the same
- Growth stocks did a little better than Value stocks
- The proprietary Lowry's measure for US Market Buying Power is currently at 162 and rose by 5 points last week and that of US Market Selling Pressure is now at 136 and fell by 3 points over the course of the week.
- SPY, the S&P 500 ETF, rose back above both its 50-day and 90-day moving averages and remains above its long term trend line. SPY ended the week 12.5% below its all-time high (01/03/2022).
- QQQ, the NASDAQ-100 ETF, remains above both its 50-day and 90-day moving averages and its long term trend line. QQQ ended the week 19.3% 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 1.6 higher at 21.7. It moved back below its 50-day moving average and is still below its 90-day and its long term trend line.
ARTICLE OF THE WEEK ..
Contrarian take from MIT onChatGPT and the other AI engines, which may fall far short of what they are cracked up to be. Why trusting them may be a mistake.
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 bank run occurs when a large number of customers of a bank or other financial institution withdraw their deposits simultaneously over concerns of the bank's solvency.
As more people withdraw their funds, the probability of default increases, prompting more people to withdraw their deposits. In extreme cases, the bank's reserves may not be sufficient to cover the withdrawals.
Bank runs happen when a large number of people start making withdrawals from banks because they fear the institutions will run out of money. A bank run is typically the result of panic rather than necessarily a true insolvency. A bank run triggered by fear that pushes a bank into actual insolvency represents a classic example of a self-fulfilling prophecy. The bank does risk default, as individuals keeping withdrawing funds. So what begins as panic can eventually turn into a true default situation.
That's because most banks don't keep that much cash on hand in their branches. In fact, most institutions have a set limit to how much they can store in their vaults each day. These limits are set based on need and for security reasons. The Federal Reserve Bank also sets in-house cash limits for institutions. The money they do have on the books is used to loan out to others or is invested in different investment vehicles.
Because banks typically keep only a small percentage of deposits as cash on hand, they must increase their cash position to meet the withdrawal demands of their customers. One method a bank uses to increase cash on hand is to sell off its assets—sometimes at significantly lower prices than if it did not have to sell quickly.
Losses on the sale of assets at lower prices can cause a bank to become insolvent. A bank panic occurs when multiple banks endure runs at the same time.
Bank runs go back as early as the advent of banking, when goldsmiths in Europe during the 15th and 16th centuries would issue paper receipts redeemable for physical gold in excess of the stock that they held. This was an early example of fractional reserve banking, whereby bankers could issue more paper notes redeemable for gold than they held in stock.
The concept was viable since the goldsmiths (and more modern bankers) knew that on any given day, only a small percentage of gold on hand would be demanded for redemption. However, if depositors suddenly demanded their gold deposits all at once, it could spell disaster —and this did happen several times in response to poor harvests or political turmoil.
In modern history, bank runs are often associated with the Great Depression. In the wake of the 1929 stock market crash, American depositors began to panic and seek refuge in holding physical cash. The first bank failure due to mass withdrawals occurred in 1930 in Tennessee. This seemingly minor and isolated incident, however, spurred a string of subsequent bank runs across the South and then the entire country as people heard what happened and sought to withdraw their own deposits before they lost their savings—a herding behavior that only sped up more bank runs via a negative feedback loop.
Rumors began to spread that banks were refusing to give customers back their cash, causing even greater panic and anxiety amongst the public. In December 1930, a New Yorker who was advised by the Bank of United States against selling a particular stock left the branch and promptly began telling people the bank was unwilling or unable to sell his shares. Interpreting this as a sign of insolvency, bank customers lined up by the thousands and, within hours, withdrew over $2 million from the bank.
The succession of bank runs that occurred in the early 1930s represented a domino effect of sorts, as news of one bank failure spooked customers of nearby banks, prompting them to withdraw their money, where a single bank failure in Nashville led to a host of bank runs across the Southeast.
In response to the bank runs of the 1930s, the U.S. government set up several regulatory mechanisms to prevent this from happening again, including establishing the Federal Deposit Insurance Corporation (FDIC), which today insures depositors up to $250,000 per banking institution.
The 2008-09 financial crisis was again met with some notable bank runs. On September 25, 2008, Washington Mutual, the sixth-largest American financial institution at the time, was shut down by the U.S. Office of Thrift Supervision. Over the previous few days, depositors had withdrawn more than $16.7 billion in deposits, causing the bank to run out of short-term cash reserves.
The very next day, Wachovia Bank was also shuttered for similar reasons, when depositors withdrew over $15 billion over a two-week period after Wachovia reported negative earnings results earlier that quarter. Much of the withdrawals at Wachovia were concentrated among commercial accounts with balances above the $100,000 limit insured by the Federal Deposit Insurance Corporation (FDIC), drawing those balances down to just below the FDIC limit.
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