ANGLES.

Note: this report was completed before confirmation of the debt ceiling deal reached by negotiators. See my subsequent post: “Debt Ceiling Update”.

Stocks skidded lower most of the week, giving back a lot of the previous week’s gains, as there was minimal reported progress towards a debt ceiling deal between the White House and Congressional Republicans. Talks seemed to collapse and restart over and over again with negotiators constantly talking out of both sides of their mouths so as to make absolutely nothing any of them said ever remotely believable.

We are now just days away from Treasury Secretary Janet Yellen’s newly-firmed up “X” date of June 5th, when the federal government is expected to “have insufficient resources to satisfy its obligations” which could result in the cancellation of social security payments, federal employees’ salaries and the repayment of national debt.

Also, any agreement will still need to go swiftly through the House and the Senate where it could be at the mercy of arsonists like Boebert, Taylor-Greene, Roy, Lee and (as ever) Rand Paul. Keep an eye on these particular lawmakers in the next week or so. Meanwhile, on the other end of the economic brainpower spectrum, the International Monetary Fund (IMF) said on Friday that the political brinkmanship in Washington is in danger of creating an “entirely avoidable” systemic risk to the global economy and called for the ceiling to be raised "immediately”.

And the fact is that, even if there is some kind of resolution, the spending cuts required to get Republicans to an agreement may cost as many as 570k jobs (as reported by Bloomberg) and will likely of themselves push the country over the edge by crashing growth and sending the economy reeling into austerity at precisely the wrong time when it is on the brink of a potentially significant recession.

But the damaging fallout from all this nonsense has already started anyhow. DBRS Morningstar last week placed the AAA sovereign credit rating (see EXPLAINER: FINANCIAL TERM OF THE WEEK below) on the United States “under review with negative implications.” Fitch Ratings said that it may downgrade its US sovereign credit rating by placing it on what it calls a Rating Watch Negative reflecting the worsening partisan s**t-show (my word, not theirs) that’s preventing a deal.

It’s about managing fear and jitters as much as anything else - the stock market even briefly reacted negatively to a report last week that Federal Reserve Chair Jerome Powell might have been spotted near the Capitol building. The yield on the one-month US Treasury bill, which straddles the X-date and is currently acting as a “fear gauge” for default risk, is now at a record high of above 6% (see US TREASURY INTEREST RATE YIELD CURVE below).

The market-generated probability that the Fed has now ended its campaign of rate hikes next month crashed from a near-certainty (83%) of a pause just a week ago to not even very likely by Friday (29%). And conviction that interest rates will be lower at the end of the year than they are now has collapsed from a literal 100% certainty just two weeks ago to only 40% by Friday (see FEDWATCH INTEREST RATE PREDICTION TOOL below).

Sentiment rapidly reversed after the St. Louis Federal Reserve President James Bullard said on Monday that he’s thinking there’ll be two more interest rate increases this year. As he loves to do from time to time, Minneapolis Fed President Neel Kashkari threw even more fuel onto the fire when he said that even if the US central bank were to pause next month, it should simultaneously signal that the hiking process is not over. In other words, no hike in June absolutely does not mean no hike in July.

Also playing into the higher rather than lower interest rate narrative is the latest Personal Consumption Expenditures (PCE) inflation report released on Friday. The Fed’s preferred inflation measure rose 0.4% over the last month and is up 4.4% vs. a year ago, still more than double the Fed’s target rate.

Earnings from Lowe’s (LOW) echoed and reinforced concerns expressed recently by other major retailers, including Home Depot (HD), about the health of the American consumer. This did not help sentiment early in the week in a market already pre-disposed to heading lower in response to the shenanigans in DC.

On the other hand, blockbuster AI chip-driven earnings from Nvidia (NVDA) and Marvell Technology (MRVL) single-handedly salvaged some of the more ‘risk-on’ corners of the market on Thursday and Friday, at the end of what was otherwise a pretty dismal week for stocks all round. Unlike NFTs (remember them?) and some other types of crypto-adjacent rubbish, AI does appear to be a gold rush that may possibly be real and functional, rather than just some hollow hypes being bigged up by a few money-grubbing bros.

I am frequently asked why stocks are mostly holding up in the face of headwinds like an apparently imminent recession, big earnings declines and debt default? Well, the fact is that these bad things haven’t happened yet and that has caused stocks to lift and for the rally to be fueled by under-invested investment professionals who have been worried about all these things having to chase returns higher. Remember that everything in financial markets is relative to expectations and in 2023 the expectation has generally been, thanks to the historic rate hikes of 2022 and persistent inversion of the yield curve for the best part of a year now, that there will be a significant and potentially damaging recession any minute now.

However, it’s important to remember that “not yet as bad as feared” is still not “good”. Slowing economic growth and falling earnings are still not a positive, even if they are diminishing at a slower pace than many worried they would, and - as I have said before - this leaves the stock market very vulnerable to any downside surprises or disappointments that may emerge going forward.

What we need are actual positive resolutions from the issues that overhang the markets, i.e., a clear soft landing, earnings stability (which keeps valuations reasonable), a sensible debt ceiling deal very soon and confirmation from the Federal Reserve that rate cuts are coming sooner rather than later (the long sought-after pivot). Give us all those and then maybe we can start thinking about a real and sustainable market turnaround.

Absent that, short and medium term caution is still warranted.

OTHER NEWS ..

Feeling poorer .. 35% of Americans said their financial situation was now worse than it was a year ago, according to the annual Fed survey of American households that assesses their economic well-being. This is the largest share on record since the Fed began asking the question almost a decade ago.

The least-educated consumers were the most likely group to say they were worse off: 40% reported as much in 2022, up from 33% in 2021 and just 18% in 2019. But there was also a historic jump in higher-educated respondents who said the same; 31% reported being financially worse off, a huge surge from just 13% in 2021.

Last year saw an important shift in the pandemic-era economy, with the expiry of stimulus checks, expanded unemployment benefits and more. Also Investment portfolios shrank as stock and bond markets simultaneously declined in 2022, something that hardly ever happens.

It seems, however, that soaring costs are the biggest factor at play here. Inflation was the top financial challenge cited among people of all income levels in 2022, which suggests "a widespread effect of higher prices across the population," as the Fed writes in the report.

Reality hits home at FRB .. First Republic Bank (FRB) made its name catering to wealthy clients across California and New York, reeling in many of them with unusually sweet mortgages. The system made its employees rich. The San Francisco-based bank, which regulators seized and sold to JPMorgan Chase (JPM) early this month, is said to have been paying dozens of employees an…

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The S&P 500 is at exactly the same level it was at two years ago. That’s a lot of angst and stress expended for no net change in 24 months. As if to emphasize the point, the stock market spent large portions of last week just churning sideways on very low volume as traders monitored the reported progress in debt ceiling negotiations. These dreary spells were occasionally punctuated by bursts of activity as i) carefully-managed clues were tactically released about how the debt ceiling negotiations might be going and ii) Fed officials suddenly got very talkative again.

There are now just ten days left until Treasury Secretary Janet Yellen's June 1st deadline for when the government runs out of cash. Investors are pricing in higher risk to anything maturing within a short time of that projected date, which is why the one-month US T-Bill has become the preferred barometer for sentiment towards the debt negotiations. The higher the yield, the more concern there is (see US TREASURY INTEREST RATE YIELD CURVE below for the latest reading).

Perhaps an anonymous White House staffer put it best when they apparently said that passing the debt ceiling increase is like passing a kidney stone. We all know it will pass, it’s just a question of how difficult it will be.

Investors held their collective breath amid the latest pile of nonsense coming out of Washington DC on Monday, which saw the lowest daily trading volume of the year so far on the New York Stock Exchange. Things ratcheted up a little on Tuesday when McCarthy bizarrely bleated that the two sides were somehow simultaneously miles apart and yet maybe really close to a deal that might be just around the corner. Biden pulled a classic drama-queen PR stunt, saying he will cut short a very important Asian trip to come back early to ride to the rescue. Later in the week, the spin went into overdrive with suddenly optimistic bulletins being pushed out from both sides, each desperately trying to look like the good guy.

But then, on Friday, under increasing pressure from their own “burn-it-all-down” members to break off talks, the Republican delegation surprised precisely nobody by staging a hissy fit, flouncing out of the negotiation meeting and declaring the talks paused. The stock market eye-rolled, sighed and gave back the day’s gains.

Smoke and mirrors. I suggest not believing a single thing you hear from either side until a deal is officially done or once the nation is in a death spiral, whichever option it is these clowns choose for us.

Since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend or revise the definition of the debt limit – 49 times under Republican presidents and 29 times under Democratic presidents. It’s obviously got a load of precedent and it’s not hard to do. Just do it FFS! We need to move on to address other much more important stuff, not get wrapped up in completely unnecessary self-inflicted wounds.

Generally hawkish commentary from multiple Fed officials reminding us that the battle against inflation is still far from won means that it may now be a much closer call than we first thought whether the Fed committee continues raising rates or pauses at the next meeting in June. Markets at one point even indicated a one in three probability of a hike, up from just 12% only a week ago - before falling back again on Friday after the debt talks collapsed.

The price of shares in Home Depot (HD) fell hard on Tuesday after the biggest US home retailer reported a more than 4% drop in year-on-year revenue, missing expectations by the biggest margin in 20 years and gave pretty depressing forward guidance. More generally, however, Retail Sales on a national level (see EXPLAINER: FINANCIAL TERM OF THE WEEK below) increased in April, although the headline number was slightly lower than expected. The core number that excludes auto and gas sales was encouraging, however, with the best showing put in by online stores and restaurants and bars. This all suggests that consumer spending is broadly holding up in the face of continued economic difficulties including inflation and high borrowing costs.

When you aggregate and analyze the appropriate data, you definitely see that the odds of a soft landing (inflation eventually conquered with no recession or, at worst, a mild one) still remain higher than those of a hard landing. To be clear, this analysis does not mean a hard landing won’t happen. But so far, it is not happening. Yes, the economy is clearly slowing, but not at the pace that we’d consider yet puts us in hard landing territory.

I will, of course be keeping an eye on (and sharing with you) how these odds develop over time and there has been a recent spike in weekly jobless claims that bears watching, but at this point it’s the softies who seem in a better position than the hard-men. This is helping support stock prices, indeed the S&P 500 hit new 2023 highs at one point last week and the NASDAQ even reached its highest level in over a year.

Q1 2023 earnings season is almost over. The overwhelming expectation was that S&P 500 company earnings would fall close to 7% last quarter from the previous one. The fact is they have only fallen about 2%. As Bank of America put it last week, “it is dangerous to underestimate Corporate America's margin preservation skills.”

Stock markets are priced for a pause, a quick pivot and then multiple rate cuts by early next year. Anything less could well be a problem. The concentration of this year’s gains in a small number of big tech names (see UNDER THE HOOD below) makes the S&P 500 vulnerable to a selloff if they start to lose value, even if everything else rallies higher.

Indeed the massive irony is that if investors start to put money to work in other sectors, pivoting away from focusing just on those monster names, a buying spree could even be the catalyst for something of a sell-off at the index level.

OTHER NEWS ..

Indebted .. Consumer debt hit a fresh high in Q1 2023, pushing past $17 trillion for the first time ever, according to a report from the New York Federal Reserve.

Households added $148 billion in overall debt in the quarter. Balances are now $2.9 trillion higher than just before the pandemic. Consumers typically build up more credit card debt at the end of the year during the holiday season and then reduce those balances at the start of the year. However, for the first time in 20 years, that wasn’t the case, suggesting some households are under strain from higher prices and may be relying on credit cards to maintain spending.

The overall delinquency rate remained relatively low by historical levels at 2.6%, but the amount of debt that became delinquent is rising in most loan categories, including credit card and auto debt.

Not going back .. When average city office-occupancy rates at the start of the year surpassed 50% again for the first time since the pandemic, many landlords viewed this as a sign that employees were finally resuming their former work habits and would soon be flooding back into offices all over the country.

However, the Wall Street Journal last week reported that those office-usage rates have not budged since then, with most companies now settling into a hybrid work strategy that shows little sign of fading. About 58% of companies allow employees to work a portion of their week from home. In fact, the number of companies that actually require employees to be in the office full-time is now declining again, down to 42% from 49% just three months ago.

With employees at companies with hybrid strategies spending an average of only half the five-day work-week in the office, it isn’t surprising that these office-return rates have stalled out at around half the pre-pandemic levels. The rise in employees working from home has driven some retailers and restaurants out of business and forced owners of office buildings to either reduce rents or to just get out of the commercial real estate business by selling their pro…

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Attention on Wall Street is shifting away from guessing future interest rates to the distinct possibility of an economic downturn. And that is encouraging investors to reward the strong and punish the weak. This is causing increasing divergences between the performance of different stocks within the same index or even the same sector.

Winners offsetting losers is giving the impression of a quiet market not really going anywhere when you look down on it from an index level, but there is a lot going on under the surface.

We are also seeing bonds finally beginning to return to their historically traditional role as having a low or even sometimes reverse correlation with stocks. This was very not the case in 2022 which is why it was such a uniquely disastrous year for portfolios with diversified stock/bond allocations as everything took a dive at the same time which almost never happens for any extended period.

House Republicans and the White House are on a high-speed debt ceiling collision course with each side betting the other will blink before impact. Both camps seem to be counting on a portfolio-busting investor meltdown to do their dirty work for them when they eventually reach a face-saving compromise in the 59th minute of the eleventh hour to dodge a default. That way, they can turn around to their respective bases and say that, although they did their very best to screw over the other side, those pesky financial markets forced their hands and that, in the end, they took a decision that was in the best interests of the country. So icky.

Meantime, the picture will likely emerge on the world stage of the United States as a largely dysfunctional quasi-banana republic shooting itself in the foot and no longer worthy of a position of a leader and steward of global markets and the worldwide economy. Lots of wry smiles in Beijing, I’m thinking.

During a week in which you’d think his attention ought to be elsewhere, potential presidential candidate Donald Trump still managed to find time to hop aboard the default express, embracing the willingness (some might say eagerness) of many House Republicans to risk a US debt default as a weapon to extract political concessions. 

Speaker Kevin McCarthy also doubled down on the strategy last week, saying after a breakdown of talks with the President that the consensus among Republicans is to “keep the pressure on POTUS”. This stance is not impressing JP Morgan CEO Jamie Dimon who, along with his Goldman Sachs counterpart, preached to the choir and sent a letter to US Treasury Secretary Janet Yellen calling for an urgent and immediate increase to the debt limit.

The whole Congressional dance of death is starting to affect consumer sentiment, as represented by the latest monthly Index of Consumer Sentiment released last week, which is quickly turning sour as Americans become significantly more concerned about the health of the economy and what is looming on the horizon.

Consumer prices rose less than expected on an annual basis in April, raising optimism that stubbornly high inflation is beginning to moderate. The Consumer Price Index (CPI) measure of retail inflation was up 4.9% year-over-year, down from 5.0% in March and below economists’ forecasts. That was the lowest level for the CPI in two years. The monthly gain of 0.4% was in line with expectations. It was the 10th-straight month of lower annualized inflation, from a peak of above 9% last summer.

The CPI numbers were confirmed by the Producer Price Index (PPI) measure of wholesale inflation affecting manufacturers which was released the next day, and was pretty much in line with expectations, showing its lowest reading since January 2021.

While inflation is inching towards the Federal Reserve's 2% target, it may be a while before we get there. New York Fed President John Williams said this week that it could take as long as two years before we see inflation back where the Fed needs it to be.

Nevertheless, the two inflation reports seem to have done little to change the market’s view that the Fed will leave interest rates unchanged next month (still hovering around a 90% probability) and it’s unanimous; quite literally 100% of futures market participants believe that the Fed will have been forced to cut rates by the end of the year (see FEDWATCH INTEREST RATE PREDICTION TOOL below) even though the Fed insists that it won’t do such a thing.

Regional bank instability continued as PacWest (PACW) announced that it had lost 10% of its deposits in just a two-day period and the stock promptly fell 22% in the blink of an eye. To be clear, don’t listen to the clueless 2008 truthers on Fintok - the problem is not an insolvency one this time where the public will necessarily lose their deposits, it’s a macro-economic one resulting from a likely widespread reduction in bank capital being made available for businesses (credit contraction, as it is known on Wall Street) because of inevitably increased regulatory and FDIC insurance costs.

The likely Fed pause, better-than-feared Q1 2023 earnings and most of the May economic data so far have all been kind of okay and generally a somewhat muted net positive for stocks. But most of these factors are also already priced in and none of the major issues that could cause a sharp market decline (a nasty recession, inflation stickiness, more regional bank issues, debt ceiling chaos etc.) have yet been eliminated.

In other words, all that’s happening is that already-existing expectations are being mostly met and validated. It’ll take a substantial improvement in multiple market influences to push stocks meaningfully higher from here. Meanwhile the risk to the downside brought about by any kind of disappointment remains elevated.

OTHER NEWS ..

We’re happier, especially the guys .. The Wall Street Journal reported last week that job satisfaction among Americans hit a 36-year high in 2022, reflecting two effects of the tight pandemic labor market: the quality of jobs improved as wages and work flexibility increased and workers moved into positions that were a better fit.

Last year, over 62% of U.S. workers said they were satisfied with their jobs, according to new data from the Conference Board, up from 60% in 2021 and 57% in 2020. The business-research organization polled workers on 26 aspects of work and found that people were most content with their commutes, their co-workers, the physical environment of their workplace and job security.

Among the happiest workers: people who voluntarily switched jobs during the pandemic and individuals working in hybrid roles with a mix of in-person and remote work. Men’s satisfaction was higher than women’s in every component, especially in areas such as leave policies, bonus plans, promotions, communication and organizational culture.

Icahn follow up .. In last weekend’s report, I mentioned Hindenberg Research’s report targeting Icahn Enterprises (IEP). Indeed, the research firm has since doubled down on its IEP accusations with even more criticisms of the company and its larger-than-life founder Carl Icahn. Maybe someone over at the US Attorney’s Office for the Southern District of New York read their copy of Angles last Sunday as it contacted IEP last week asking for information about the value of its assets, corporate governance, dividends and other topics. IEP said in a filing that it is cooperating with the investigation and doesn’t believe it will have a significant impact on the firm.

Hmmm, I’m not so sure about that, Carl - the firm’s share price straight away dropped by 15% when news of the probe broke and ended the week over 76% below its all-time high.

Biking to oblivion? .. Shares of Peloton Interactive (PTON), priced above $167 as recently as 2021, closed last week below $7 after being told to recall over two million exercise bikes following reports of injuries caused by seats breaking during use, the US Consumer Product Safety Commission (CPSC) said on Thursday. The recall piles more pressu…

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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 s**t-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). …

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With trading volumes contracting rapidly, the stock market - at least as represented by the major indexes - was acting early last week like it had already checked out for summer and it’s not even May yet. It was proving to be something of a snooze-fest with a generally negative tilt as far as the headline indexes were concerned. But under the surface, things were playing out rather differently.

Earnings and guidance are generally holding up better than expected, mostly beating estimates at a good clip - notably Microsoft (MSFT), Alphabet/Google (GOOGL), Meta/Facebook (META) and Intel (INTC) last week. Indeed, 83% of non-financial companies have beaten earnings estimates so far this season (only 57% of financials).

This high beat-rate is, of course, a lot easier when the bar of these estimates has been consistently lowered by companies in considerably despondent forward guidance over the last couple of quarters banging on and on about how difficult 2023 was going to be. After all, the stock market is all about expectations versus reality.

Of some concern, however, is the fact that those firms whose earnings are failing to beat estimates seem to mainly be those that have their fingers on the pulse of the demand side of the economy, such as UPS, Caterpillar (CAT) and Packaging Corp of America (PKG) - and a number of these stocks got punished last week after announcing disappointing earnings and/or very cautious commentary/guidance.

So while macro-economic data is still broadly leaning towards a soft landing scenario (inflation to be conquered without a highly damaging recession), the micro-economic data around which types of companies are hurting more than others may be pointing in the other direction.

Early in the week, First Republic Bank (FRC) reported that customer deposits fell 40% or $72 billion in the first quarter during a ham-fisted earnings call. The already-incinerated stock got cut in half again in a matter of hours and then tumbled a further 30% the next day. On Friday, the stock price got cut in half yet again in the after-hours. While the market has now basically given up on First Republic as a viable stand-alone entity (rumors abound about a JP Morgan or PNC Bank absorption), the real damage will come if there are signs of further contagion into the likes of Zion Bank (ZION), Comerica (CMA), Bank of Hawaii (BOH) and Western Alliance (WAL).

It’s a sharp reminder that the banking sector is not yet out of the woods and indeed may well experience more pain ahead as a result of also being so entangled in the increasingly troubled world of commercial real estate that is suffering from enormously higher interest rates and vastly lower occupancy rates. A revival of banking stress simply isn’t priced into this market and its return will prove troublesome if it happens.

Stocks finished the week a touch higher after a mostly tranquil Monday, a difficult Tuesday and Wednesday but a powerful resurgence on Thursday and Friday as markets basked in the sunlight shone by earnings and guidance from some of the mega-cap tech names (FAAMG stocks, see EXPLAINER: FINANCIAL TERM OF THE WEEK BELOW). For the month of April, the S&P 500 added 1.5%, while the NASDAQ squeezed out just a small gain. 

Congressional lawmakers’ continued reckless posturing around the debt ceiling appeared last week to have finally just about made it onto the radar of markets, although hardly in a meaningful way yet. For the moment at least, it still has the feel of a parent rolling their eyes after just noticing for the first time that their two toddlers are bickering over a toy. But the longer this nonsense goes on without resolution and the specter of 2011 starts emerging, the more nervous markets are going to get and the more a disastrous and completely unnecessary own goal becomes a possibility.

The Federal Reserve’s favorite inflation measure, the Core Personal Consumption Expenditures (PCE) Price index ticked down only slightly, showing 4.6% inflation year-on-year, down from 4.7% a month ago, denting the assumption that inflation is coming down hard and pretty much cementing the fact that the Fed will raise interest rates by another 0.25% this coming Wednesday (still hovering above an 80% probability, see FEDWATCH INTEREST RATE PREDICTION TOOL below).

At first glance, the second estimate (of three) of Q1 2023 US Gross Domestic Product (GDP) numbers looked grim; rising at an annualized rate of just 1.1% versus the median expectation of 1.9% and far below the 2.6% growth in Q4 2022.

The underlying details look more encouraging, however. The biggest drag by far came from a huge swing in business inventories but that category is highly volatile and subject to big quarter-to-quarter moves.

The data also confirmed that business activity is stalling out as borrowing costs rise. Spending on new buildings, equipment and more rose by just 0.7% in Q1 2023 as compared to 6.0% and 4.0% the two previous quarters.

The housing recession was the first to show itself as being affected by the Fed’s interest rate hike campaign that started exactly a year ago. But the worst may now be over, with the sector becoming less and less of a drag on growth. As recently as Q3 2022, residential investment was plunging at a 27% annualized pace. In Q1 2023, it declined at barely a 4% rate.

The interpretation of the GDP numbers actually pushed back on the idea of a hard landing and it was that which cleared the way for the strong earnings from many of the big dogs to catapult stocks meaningfully higher over the last couple of trading days, along with the market’s persistent faith in the Fed’s “hike/pause/pivot/cut” narrative, part one of which comes into play this week with the latest Fed interest rate decision announcement.

The way this narrative sees things panning out is that a 0.25% hike on Wednesday afternoon will be the last as the central bank heads into a period of pause before pivoting to rate cuts before the end of the year. Certainly very possible but, as I have been saying, this world-view is so accepted and widespread (the futures market says that the probability of rates being higher at the end of the year than they are now is quite literally only at 3%, even though the Fed is insisting that they will not cut in 2023) that there is a lot of potential for disappointment if things don’t quite go as planned and that disappointment could translate into lower prices.

OTHER NEWS ..

80%-off sale .. The Wall Street Journal reported last week that a 22-story glass-and-stone office skyscraper on California Street in San Francisco, once home to some of the world’s most valuable commercial real estate, is expected to draw bids of about $60 million, compared with an estimated value of over $300 million in 2019. The office market is being hit nationwide, but San Francisco’s blow was especially hard, for reasons including high costs, heavy reliance on a tech industry quick to embrace hybrid work, and quality-of-life issues such as crime and homelessness.

Bye, bye BBBY .. The effort to save Bed Bath & Beyond (BBBY) has finally failed and the stock is plunging into the abyss. The struggling retailer announced it had filed for Chapter 11 bankruptcy protection after being unable to raise enough funds to keep it afloat and will liquidate. 

The company explained that it would continue to keep its remaining 360 stores stores open for the time being, but would begin to “effectuate the closure of its retail locations.” Bed Bath & Beyond also noted that while it has already started its liquidation process, it intends to use the Chapter 11 proceedings to “conduct a limited sale and marketing process for some or all of its assets”.

The stock had been a favorite of so-called “meme-stock” novice amateurs who kept on buying it as part of a self-styled war against institutional short-sellers. It looks like the retail day-traders are ending up on the wrong side of things yet again.

Less smoke .. We're all smoking far less but the most dr…

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It is said on Wall Street that the goal of the market is to extract the maximum amount of pain from the greatest number of people. What this is getting at is that when everyone is positioned as bullish, the pain trade is for markets to move lower. When everyone is bearish, the pain trade is for them to go higher.

As such, the pain trade has been mostly inflicted on the bears so far in 2023 and is helping support stocks, despite decidedly dodgy economic fundamentals. Sentiment matters in the short-term and so the pain trade was to push the market higher to some degree, especially after general caution gave way to fully-fledged bearish sentiment following the bank failures in mid-March and increasing evidence that the economy may be starting to crash.

However, it seems that sentiment may shifting again after some surprisingly decent early earnings reports, recent hopeful inflation data and the end of rate hikes finally coming into view. It’s worth keeping an eye on sentiment in this regard (I show the latest AAII Investor Sentiment Index readings every week in this report, see below) as the direction of the pain trade may be about to flip.

For the moment markets remain resilient, but that resiliency has been underpinned by the aggressive idea of an imminent “Fed hike/pause/pivot/cut” interest rate narrative and an only-gradual slowing of economic growth. We won’t know if this thesis is correct until we can properly assess how deep the economic slowdown is going to be.

While the chances of the US completely avoiding a recession seem small, there is still a very legitimate possibility that it may only be a mild one. Consider the following ..

• The S&P 500 is up 25% from the pre-pandemic levels of January 2020.

• The National Home Price Index is up 38% from January 2020.

• Wages have risen 53% since January 2020.

• Pandemic stimulus across 476 million payments totaled more than $814 billion-worth of deposits which went straight into the pockets of American consumers.

• 90% of the $770 billion Paycheck Protection Program (PPP) loans have been completely or partially forgiven, injecting massive stimulus into the economy.

The critical point here is that consumers have simply had more money to work through before they have to start changing their behavior in response to inflation and the Fed’s interest rate hikes. This goes a long way to explaining why the Fed has had to raise interest rates again and again and again at a historically unprecedented rate of basically 0% to 5% in the space of a year, simply in order to get the attention of the American consumer who entered last year flush with stimulus money, a suddenly much more valuable home bought or re-financed using an ultra-low fixed rate mortgage, higher wages and a fatter investment portfolio. The result was that turbo-charged rate hike campaign that severely damaged both the stock and bond markets which made 2022 uniquely painful even for the most diversified of portfolios.

The first shots were fired last week in the upcoming congressional grandstanding about the debt ceiling (see EXPLAINER: FINANCIAL TERM OF THE WEEK below). “Let me be clear: a no-strings-attached debt limit increase cannot pass .. debt limit negotiations are an opportunity to examine our nation’s finances." bellowed House Speaker Kevin McCarthy during a speech at the New York Stock Exchange, of all places. Chuck Schumer shot right back,"If Speaker McCarthy doesn't change his course, he could well take this country to default."

Investors aren't yet paying any serious attention to the back-and-forth sniping, even though the last serious debt ceiling battle in 2011 did cause tumbling markets and a downgrade of US debt. While we can expect some occasional short-term market volatility at times when the irksome squealing reaches fever pitch, I think it is very important to maintain a distinction between tiresome short-term Washington gamesmanship and any potential long-term damage to investment portfolios.

Traders seem to have settled into the idea of a quarter-point rate increase from the Fed next month (that probability is now up to 89%, see FEDWATCH INTEREST RATE PREDICTION TOOL below) and early earnings have been mostly fine, with just a few disappointments here and there. The result has been a collective yawn for much of the last week or two. But with earnings about to hit full steam this week (see THIS WEEK’S UPCOMING CALENDAR below), investors will finally have plenty to think about beyond just inflation, interest rates and yield curves. Earnings season has a way of returning investors' attention to the fundamentals and the bottom line.

One of the single, most dominant market dynamics right now is the deeply inverted yield curve and, for that reason, starting this week I have begun to monitor it as one of my important data points shown in this report each week (see US TREASURY INTEREST RATE YIELD CURVE below).

OTHER NEWS ..

Due Diligence Queen .. Investors recently launched lawsuits against Sam Bankman-Fried, the disgraced crypto bro founder of FTX and also against those who shilled for him in return for very large compensation, including quarterback Tom Brady and his ex-wife, Gisele Bündchen, Larry David, Kevin “Mr. Wonderful” O’Leary, David “Big Papi” Ortiz, tennis player Naomi Osaka as well as the NBA’s Steph Curry and Shaquille O’Neal. They were all charged along with others with taking a lot of money in order to participate in the duping of the millions who lost billions when SBF’s crypto house of cards came tumbling down.

However, there was one person who was smart enough not to fall for the hype. It emerged last week that, unlike the afore-mentioned money-grubbing band of hoodwinked celebs who’ll obviously say anything for a buck without looking into what it is they are peddling or any of their highly-compensated advisors who push them to do so in order to earn their own slice of the pie through commissions, Taylor Swift apparently thought to actually ask about the status of the investments as “unregistered securities”, promotion of which for financial gain makes an individual liable to claims for damages. She obviously did not like the answer she got since she declined the opportunity to promote SBF and his fraudulent enterprise.

You can shove your savings account .. Higher interest rates have so far been good news for the big banks, which have been able to charge borrowers more on loans and credit cards, but not pay as much interest to depositors. Currently, the annual interest rate paid to customers by big bank savings accounts averages a miserly 0.37% as opposed to an easily available 4.35% or more elsewhere).

Unsurprisingly, the banks’ clientele is increasingly telling the banks to stick their savings accounts and is moving its money into deposits at these other institutions and instruments that pay a much higher interest rate with zero fees and sometimes much higher levels of FDIC or SIPC insurance coverage than the traditional $250k per account offered by high street banks.

Credit spike .. Despite increasing interest charges, Americans spent big on credit cards in Q1 2023, according to an article in the Wall Street Journal last week. Bank of America said that spending on its credit cards rose 6% from a year earlier. Credit card spending was up 13% year-on-year at JP Morgan, 7% at Citigroup and 16% at Wells Fargo. Overall credit card loan balances rose sharply at the four banks, a sign that a growing number of people are now not paying off their full balances each month.

UNDER THE HOOD ..

Anyone measuring the stock market’s health solely by the gains made in the S&P 500 is not seeing the big picture. While the index, along with its large-cap cousins, the Dow Jones Industrial Average (DJIA) and the NASDAQ, have enjoyed respectable gains since early March, this has obscured the fact that smaller stock indexes are still reeling from the bank-induced sell-off six weeks ago. When it is only the largest and most high profile portion o…

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Last week was a busy one with plenty of economic data to chew on and lots of soundbites from International Monetary Fund (IMF) officials and Federal Reserve presidents. It also marked the opening of the Q1 2023 earnings season.

Monday started out mostly jittery and trendless as the stock market tried to digest the Jobs Report from the holiday Friday before. Interestingly, the laggards were stocks in the defensive sectors like Utilities and Consumer Defensive that had outperformed the previous week, as worries eased about the prospect of an economic “hard landing” (i.e. inflation is only finally killed by a nasty recession).

The IMF said that the rampant inflation around the world of the past year or so, along with accompanying higher interest rates, will turn out to be just a blip on some charts. The recent banking turmoil (I think it’s generally agreed now that the term “banking crisis” is an overblown description of what happened and needs to be downgraded to “banking turmoil”) illustrates the concerns IMF economists have been voicing for a while as central bankers continually tighten monetary policy and raise interest rates.

“Downside risks dominate and the fog around the world economic outlook has thickened,” wrote IMF Director of Research Pierre-Oliver Gourinchas, bringing to mind the writing style of Charles Dickens who was, of course, the author of both “Hard Times” and “Great Expectations” - which, when combined, seem to conveniently express the two ends of the spectrum of the economic outlook right now.

The Consumer Price Index (CPI) measure of retail inflation came out on Wednesday and showed a rise of just 0.1% from February to March, lower than the expectation of 0.2% after the previous month’s 0.4% gain. Annualized inflation in the US is now running at 5.0%; below expectations, the lowest level since May 2021 and down from 5.5% the month before.

Inflation might be cooling according to some metrics, but it isn't completely going away. Excluding volatile food and energy components, Core CPI actually accelerated a bit, ticking up 0.4% month-to-month and is up 5.6% year-on-year vs. 5.5% the previous month. Rises in the cost of housing and shelter was the largest contributor to the monthly increase.

The good news piled up the next day when we saw the Producer Price Index (PPI) measure of wholesale inflation affecting manufacturers (which is kind of a leading indicator for retail inflation). PPI fell 0.5% from February to March after being unchanged the previous month. The biggest factor was a sharp decline in gasoline costs. The annualized reading was up just 2.7%, falling precipitously from 4.9% the month before.

The fact is that many categories of goods have now returned to pre-pandemic levels of inflation and many commentators believe that is a good enough reason for the Fed to stop raising interest rates immediately. Futures markets are currently showing that probability as being 22% with a 78% chance of a 0.25% increase at the next meeting in early May (see FEDWATCH TOOL, below).

This heightened expectation of a maximum of just one more interest rate increase was also fueled by a slate of speeches midweek from Federal Reserve officials. Minneapolis Federal Reserve President Neel Kashkari said that he foresees headline inflation falling to the “the mid 3’s” by the end of 2023 and move closer to the Fed’s target range of 2.0% by next year. New York Fed President John Williams spoke about how he believed that the recent failures of Silicon Valley and Signature Banks were “unique” and “unlikely to reflect the broader trends in the financial system.” That helped ease some of the lingering market angst about the health of the banking sector.

The newly-released minutes from the Fed’s most recent policy-making meeting revealed that members anticipate a mild recession this year in the US partly because of the fallout from last month’s banking turmoil. They also projected that the unemployment rate will rise another full percentage point by the end of the year — an event that historically has only ever occurred during a recession.

Friday’s much better-than-expected Q1 2023 earnings from some of the big box banks was swiftly overshadowed by the release of data that showed consumer spending falling twice as much as expected in March. Retail Sales declined by a full 1.0% last month, much more than the expected 0.5% decline, as consumers seem to be increasingly keeping their hands in their pockets. It’s yet another sign that it's probably only a matter of time before a recession of some kind fully engulfs the US economy and the stock market ended Friday on a downbeat note, although the headline indexes were a little higher for the week overall.

The biggest question for markets is now not so much “will there be a recession?” , I think everyone now assumes that there will be - and pretty soon. It’s more about whether the recession is going to be an extended, deep and painful one (“Hard Times”) that results in sharp equity market losses and broader turmoil across financial markets or a shallow and relatively short-lived one (“Great Expectations”) that markets will be able to weather fairly well. The answer to that question still remains to be seen, but we are definitely getting closer to learning which it is.

The rally in March and April in stocks and bonds has been driven by anticipation of a“Fed hike, pause, cut” narrative, not actual hard improvement. That doesn’t mean it’s wrong (these expectations could end up being entirely accurate), but it does leave markets vulnerable to disappointment and if that disappointment comes about (a delayed pause? No prospect of a cut this year?), a 5%-10% pullback in stock prices shouldn’t surprise anyone.

Watch this space.

OTHER NEWS ..

Stamp-flation .. The price of postage stamps is poised to increase again in July for the second time in 2023 and the 17th rate change since 2000, under a new proposal by the US Postal Service (USPS). If approved by the Postal Regulatory Commission, this would be the shortest time between increases in history. Rates last went up just three months ago and before that, in July 2022. In contrast, between 1970 and 2000, rates only increased once on average every two to three years.

The Postal Service said the proposed increases raise first class mail by approximately 5.4% to “offset the rise in inflation” and are needed “to address continued elevated inflation and prior years defective pricing model”.

With the proposed rates, postage for a first class 1-ounce letter will go to 66 cents, up from 63 cents and 2x the 1999 rate of 33 cents. The Postal Service said it is also "seeking price adjustments for Special Services products including Certified Mail, Post Office Box rental fees, money order fees and the cost to purchase insurance when mailing an item".

Much less swiping going on .. Office vacancy rates hit a record high in New York and rose nationwide as tenants cut back on space they don't need because so many employees are working from home.

In New York City, the office vacancy rate rose to a record 16.1% in Q1 2023, representing more than 76 million square feet of empty office space, according to a report by commercial real estate firm, JLL. As office leases, which typically run 10 years or more, expire, companies are reassessing their space needs and not in a good way for the commercial real estate market in New York.

That vacancy rate means about 84% of available space is theoretically being leased but that absolutely does not mean that it's all being used. New York's actual office occupancy rate is more like around 49%, according to Kastle Systems, which tracks card swipes through its security systems.

Careful what you wish for .. If history is any guide the market may be overestimating the positive effects of interest rate cuts, if they happen. The previous occasions when the Fed has embarked on a meaningful rate-cutting cycle have tended to work best (i.e., resulted in very positive stoc…

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The week and the month began with investors shifting their attention away from March's banking turmoil and back to the risk of a recession that could drag down consumer spending, thereby corporate profits and thereby stock prices. And the holiday-shortened week provided plenty for them to focus on.

Unexpected output cuts from the Organization of Petroleum Exporting Countries (OPEC, see EXPLAINER: FINANCIAL TERM OF THE WEEK below) were announced on Monday after oil prices dipped in March amid the banking stress and fears over the global economic outlook.

Unsurprisingly, oil prices and oil stocks soared to start the quarter’s first trading day, as did the odds of another quarter point hike by the Federal Reserve next month. That’s because higher oil prices is a potential blow in the Fed’s battle against inflation, a fight it had looked to be slowly winning.

The White House got very grumpy about the move. It was apparently made clear through diplomatic channels that, given the cost of living issues in the US and broad market uncertainty, it considered this production cut as “ill-advised”.

Pretty much all the economic data released before the big one (the Jobs Report on Friday) implied that the economy isn't just lifting its foot off the gas pedal, it may now be stomping on the brakes.

The US manufacturing activity index fell to 46.3, to its lowest level since it completely collapsed back in those frightening dark days of May 2020. Numbers below 50 indicate contraction and by this index, manufacturing has now been contracting for four straight months. The overall reading has fallen to this level only sixteen other times in the index’s history dating back to 1948. In twelve of those sixteen instances, the economy was either already in a recession or fell into one shortly after.

Employers seem to be finally pulling back from their breakneck, hire-at-all-costs approach of 2022. The Job Openings and Labor Turnover Survey (JOLTS) for February showed a very sharp 632k decline in job openings to a much lower total of 9.93 million with declines across all industries and sectors. Estimates had been for 10.45 million openings. This represents over 2 million fewer job openings than there were a year ago. For context, however, the pre-pandemic record-ever high in job openings was around 7.5 million. Another example of how the pandemic broke data.

We also learned that service industry expansion was coming to a screeching halt and that factory orders were disappointing.

The market seemed somewhat confused and appeared unsure which way to react. There was push-me/pull-you pressure being exerted on stock prices from two distinctly different camps.

The optimists’ case was that all this recession-pointing data took a lot of pressure off the Fed to keep raising rates and that the absolute worst case for the next meeting in early May would be one final quarter of a point hike (71% probability, see FEDWATCH TOOL below) but with a pause and no increase at all still very much on the table (29% probability). Good for stocks.

However, an increasingly common narrative is that it’s economic data, not the banking situation and not the Fed, that will mostly determine whether the next 10%-15% move in the S&P 500 is higher or lower.

That’s because the major unknown for investors is whether the economy falls into a recession or not. It’s not how much more the Fed hikes rates (we know it’s not much more, if at all), and it’s not whether the government will rescue depositors in the case of other regional bank failures (we pretty much know that they will).

On that basis, the pessimists’ case is that bad news about the economy is now simply bad news which means likely lower corporate earnings and less tolerance for risk by investors. Bad for stocks.

We then had the rather strange and unusual situation on Friday of the all-important Jobs Report coming out at 8:30am ET on a day when the stock market was closed for a holiday and therefore unable to immediately react.

Payrolls grew by 236k in March, totally in line with estimates and below the upwardly-revised 326k in February. The unemployment rate somewhat surprisingly ticked lower to 3.5% and average hourly earnings rose 0.3%, pushing the year-on-year increase to 4.2%, the lowest level for that reading since June 2021.

Although still elevated by historic standards, this increase in jobs was the smallest of the entire post-pandemic economic recovery and definitely appeared to fall into a “Goldilocks” sweet spot of not too hot (which could embolden the Fed to definitely keep raising rates) and not too cold (stark evidence of a recession).

OTHER NEWS ..

Layoffs soaring .. US employers have recently dealt with higher borrowing costs and moved to reduce expenses by increasingly laying off staff, according to executive coaching firm Challenger, Gray & Christmas.

US employers announced 89k job cuts last month alone, a 15% increase from February and a rise of over 300% compared to March 2022, continuing a trend seen all year so far. For Q1 2023, layoff announcements skyrocketed by almost 400% from Q1 2022.

Technology workers have been the hardest hit, with 38% of all layoffs so far this year coming from that sector. Over 100k employees have been laid off from tech firms so far in 2023, a massive jump from the same period last year. 

Poor reward .. The reward offered for owning stocks over bonds hasn’t been this small since before the 2008 financial crisis. This reward is known as the Equity Risk Premium (ERP); the gap between the S&P 500’s earnings yield and that of the 10-year Treasury Bond currently sits at around 1.6 percentage points, a low not seen since now-notorious convicted crypto shiller Soulja Boy first suggested that we crank that in 2007. That is well below the average gap of around 3.5 percentage points since then.

The reduction is a potential challenge for stocks going forward. Owning stocks needs to promise a meaningfully higher reward than owning bonds over the long term. Otherwise, taking the higher risk of owning equities relative to holding risk-free US Treasury bonds would begin to stop making sense from a risk/return standpoint and liquidation of stocks for the purchase of bonds would likely accelerate, driving stock prices lower.

UNDER THE HOOD ..

Only 25% of the stocks in the S&P 500 are currently outperforming the index. Read that again, it’s a remarkable statement. This low level has only been reached a few times in history. This is the very definition of a market (as determined by a headline index) being propped up by just a relative handful of very large (mostly tech or tech-adjacent) stocks.

This degree of concentration is confirmed by the fact that the smaller the capitalization index, heading down from Mega Cap to Large Cap to Mid Cap to Small Cap to Micro Cap, the weaker the price performance. This makes uncomfortable reading for the bulls as sustainable turnarounds have historically been led by stocks on the smaller end of the capitalization spectrum.

Prime technical indicators getting back towards news highs would be a minimum requirement for an improved environment, but that is simply not what is in place today. The probabilities therefore favor a continuation and even a possible acceleration of the primary trend which is still a downward one, which could still possibly take prices back down to, and maybe even break through, those lows of October last year.

Anglia Advisors clients are welcome to reach out to me to discuss market conditions further.

AVERAGE 30-YEAR FIXED RATE MORTGAGE ..

* 6.28%

(one week ago: 6.32%, one month ago: 6.65%, one year ago: 4.72%)

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: 33% (22% a week ago)

* ↔ Neutral: 32% (32% a week ago)

* ↓Bearish: 35% (46% a week ago)

* Net Bull-Bear spread .. ↓Bearish by 2 (Bearish by 24 a week ago)

Weekly data courtesy of: American Association of Individual Inv…

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The S&P 500 ended the week, month and quarter sitting almost exactly in the middle of its range over the last year and a strange calm seems to have descended upon markets. No scary news from the banking sector last week allowed investors to focus on other things, such as earnings and economic releases, which were mostly pretty good.

Traders started the week with a smile on their faces as they learned that First Citizens BancShares (FCNCA), a North Carolina-based regional bank, had agreed to take over substantially all of the assets and liabilities of collapsed Silicon Valley Bank (SVB).

The big economic news of the week was the release of the Personal Consumption Expenditures (PCE) Price Index. This is the inflation reading that the Fed trusts for measuring inflationary pressures even more than the Consumer Price Index (CPI) as it believes it more closely tracks spending decisions by US consumers and therefore, in many ways, it’s a more important measure when it comes to assessing the Fed’s position.

The PCE index rose 0.3% last month, less than the 0.5% expectation and well down from the 0.6% rise in January. On an annual basis, the index was up 5.0%, decelerating from 5.3% the month before. The important Core PCE Price index, which excludes volatile food and energy costs, was up 0.3% last month and is now down to 4.6% year-over-year, below the level of short term interest rates for the first time in a long time.

These numbers were all regarded as very positive and boosted optimism that the Fed might be able to pull back on their aggressive efforts to fight inflation with a possible pause next time out in May and even possible rate cuts before year-end, although Fed officials continue to deny that such rate cuts are even under consideration. It should be pointed out, however, that this data does not reflect any economic slowdown or tightening of credit conditions resulting from the bank chaos of the last two or three weeks.

This is the fear for the economy; a mini credit-crunch for corporate America (particularly small and mid-size firms), brought about by tighter lending controls instigated by the spooked banks themselves, but also coming down from the regulators.

A brief explainer/reminder of how we got here:

If you were a bank like SVB, you decided to own longer maturity 100% credit-secure US Treasury bonds that you had priced on your balance sheet as if you were going to hold them till the maturity of the bond. The fact that the current re-sale market prices of these bonds had dramatically fallen in value as interest rates have moved back higher didn’t really matter if you are going to hold on to them for their entire duration, as was the original plan, since you weren’t going to be selling them at that current price. If you aren’t selling them, why would you care what the going price is for these bonds?

Until suddenly your customers are pulling their deposits out for a variety of reasons ranging from the implosion of crypto, newly-expensive borrowing costs, VC money drying up, margin calls (see EXPLAINER: FINANCIAL TERM OF THE WEEK, below) on huge losing stock positions in tech/growth stocks - whatever it may be. And the only way to have enough money to fulfill those withdrawal obligations is to actually sell these bond assets in advance of their maturity, something you never planned to do. And all of a sudden, that much lower current price for these assets really does matter!

You are now losing millions upon millions of dollars in hours and days versus what your accountants valued the assets at, as those previously unconcerning paper losses suddenly become real losses. The rest of your customers see what’s happening and self-preservation takes over and they pull their deposits too. And so the death-spiral begins.

The reason the market responded so well to the simple fact that things didn’t get noticeably worse in the banking sector last week is because it is really, really, really important that First Republic (FRC) and any of the other at-risk regional banks like PacWest Bank (PACW), Comerica (CMA) and Zions Bancorporation (ZION) do not fail or become forcibly absorbed by a big box bank. If that happens, contagion will be confirmed and all bets are off.

And then where would the next problems become apparent? Keep half an eye on commercial real estate if that happens. In fact, come to think of it, keep half an eye on commercial real estate anyhow.

But a sense began to emerge last week that perhaps that bullet might have been dodged with no further meaningfully damaging news coming out of the sector.

The Trump circus is being completely ignored by markets and will continue to be unless something highly dramatic comes out of left field, which of course cannot be ruled out.

The short term major market focus is (in order):

* Is there an extended banking crisis?

* Will the Fed cut rates before year-end?

* Will there be a recession?

* What’s happening to inflation?

Last week, the market’s responses felt like:

* We increasingly think probably not.

* The Fed says no, we think yes.

* Maybe, maybe not - but even if there is one, it might be mild and short.

* It may be sticky in parts, but it is generally moving steadily lower.

These sentiments can change very fast from week to week obviously, but by Friday they had contributed to positive end to the day, week, month and quarter (I’ll be publishing my quarterly market review sometime this coming week).

OTHER NEWS ..

Crypto alert .. The Securities and Exchange Commission (SEC) last week issued an official warning to investors on the risks of investing in crypto asset securities. It stated what has become blindingly obvious, that crypto investments are highly volatile and speculative and that the platforms that provide them may not have the necessary protections for investors. Additionally, companies offering crypto asset investments may not comply with federal securities laws. The SEC also urged investors to exercise a lot of caution when relying on Proof of Reserves, a method used by crypto asset entities to supposedly offer evidence that they have sufficient reserve assets to cover customers' balances.

The SEC emphasized the other undeniable point that registration by entities such as Registered Investment Advisors (RIAs, like Anglia Advisors) provides important protections for investors and, conversely, unregistered entities that deal in crypto have no such protections.

The meh-taverse .. Disney last week entirely shut down the internal division that was developing its metaverse strategies. Microsoft recently permanently closed down a social virtual-reality platform that it acquired to a big fanfare in 2017. Even Mark Zuckerberg, who not long ago bet the entire farm on the metaverse, recently cut several positions and projects in Meta/Facebook’s metaverse division and focused far more on artificial intelligence (AI) on the most recent earnings call last month during which the buzzword-mention score was: AI 28, metaverse 7.

Meanwhile, the price for virtual real estate in some online worlds, where users can hang out as avatars, has completely cratered - to the surprise of almost no-one inhabiting planet Earth. Apparently, the median sale price for land in Decentra-land (yes, there is such a virtual place!) has declined 90% from a year ago.

College isn’t worth the cost, say the majority of Americans .. A Wall Street Journal survey found that 56% of Americans now think earning a four-year bachelor’s degree is a bad financial bet, up from 40% in 2013 and a new low in confidence in the monetary value of a college education. There’s a significant divergence in respondents from different age groups and skepticism is strongest among people ages 18-34. Also, the opinions of people who themselves do hold college degrees have soured the most over the last decade.

UNDER THE HOOD ..

The technical state of the market is far more precarious than is implied by the increasingly positive market sentiment described above.

The “no-man’s land” I me…

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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 authori…

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