| Don't Miss Out On The Next Leg Up In The Market By: Kevin Matras March 15th, 2023 | Ever since the markets put in their key upside reversal on October 13 (just 5 months ago), stocks have been on a tear. Even after February's pullback (following last month's hotter than expected inflation readings), and last week's banking scare, the major indexes are up still up sharply since those lows were put in, with the Dow up 10.9%, the S&P up 8.80%, the Nasdaq up 11.9%, and the small-cap Russell 2000 up 5.48%. What prompted the turnaround back then? After 3 quarters in a row of falling stock prices, and endless stories of doom and gloom, it appeared as if all of the bad news had been priced into the market. And now it was time to go higher. The recession had ended (after GDP fell in Q1 and Q2 of last year, Q3 was up 3.2%. It's no longer a recession when the economy starts growing again), and Q4 was looking up as well (we now know it was up 2.7%). And higher the market went. The market continued to rally in January. But hit the pause button in February. Last week, however, it appeared to hit the brakes. But did it? The bank implosion (and closure) of Silicon Valley Bank, and then Signature Bank, spooked the market with small and mid-sized banks tumbling. But after the Fed came out and said they would backstop all those depositors, the market bounced back up. On a side note, some have made comparisons to the Savings and Loan crisis in the late 80's, and the sub-prime mortgage crisis that took down banks in 2008. But a closer look would show they are nothing alike. For one, unlike past banking crises, SVB didn't overly invest in risky assets. To the contrary, they invested in arguably the safest investments on the planet - U.S. Treasuries. But they invested an overly large portion into long-dated Treasuries (when prices were at their highest and yields were at their lowest), and didn't adequately plan for what they would do when interest rates went up and business slowed. When their primary business model of funding startups waned, and investor dollars dried up, they found themselves in a cash crunch when their clients needed funds. SVB was well capitalized. But all that money (more than enough to meet customer demands), was tied up in long-dated (illiquid) assets. And they were forced to sell some of those Treasuries at hefty losses. (Again, those were not risky assets - those were safe, stable investments backed by the U.S. Government - and had they been able to hold them until maturity, they would have had zero losses and only gains.) Word of those losses spooked depositors and investors. SVB then made the decision to do an equity raise to ease their liquidity problem. But that led to a credit rating decline, which then led to a panic-induced bank run, and their eventual closure. This is why many analysts are saying this does not compare to the aforementioned crises. Plus, big banks are in strong financial shape. One could still point to SVB as making some poorly thought-out decisions. But throughout all of this, they had a ton of money. Just not in a place they could readily access it. A night and day difference between the current situation and the S&L and sub-prime mortgage debacles of previous years. Nevertheless, the markets tanked as investors panicked. But we all know that panic usually leads to extremes and mistakes. And I would not be surprised to see Monday, March 13, be the low of the recent pullback. Pivotal lows usually correspond with a crescendo of fear. And I would say that's precisely what we got as the SVB collapse came to a head. Now the market can get back to focusing on inflation, interest rates, and the economy. And that should lead to more gains to come. The Outlook Is For Growth The recession of 2022 has come and gone. And nobody is seriously talking about a recession anymore. How could they with Q1 GDP expected to come in at 2.6%, and the strong labor market continuing to impress? The recession is clearly behind us. And the outlook is for growth. But what about inflation, and therefore, interest rates? Have We Finally Seen Peak Inflation? Tuesday's Consumer Price Index (CPI), and Wednesday's Producer Price Index (PPI), both confirm that peak inflation is behind us and that it continues to moderate. The latest CPI report showed headline inflation at 6.0% y/y, while core inflation (ex-food & energy), was at 5.5%. That compares to last month's 6.4% headline number, and 5.6% core rate. Moreover, that's an even bigger decline from last year's summer highs of 9.1% (headline), and 6.5% (core). That was further underscored by the latest PPI report, which put the headline number at 4.6% y/y vs. last month's 6.0%, and the core rate at 4.4% vs. last month's 5.4%. That too is an even bigger decline from last year's peak inflation rates of 9.8% (headline) and 8.2% (core). Of course, inflation is still too high. And the Fed is not likely to be done raising rates just yet. But they do appear to be nearing the end of their rate hike cycle. When the Fed next meets on March 21-22, they are expected to raise rates by another 25 basis points. But gone is the speculation that they'll raise by 50 bps. In fact, even the 25 bps is not a done deal. One analysis at Goldman Sachs recently said he is no longer expecting the Fed to raise rates at all at the next meeting. As for the terminal rate, that too might be cut short. In December of last year, the Fed hinted that the terminal rate might get as high as 5.1% before calling it quits. Although, just last week, Fed Chair, Jerome Powell suggested rates could go "higher than previously expected." He did not define what that meant. But since then, others have lowered their expectations. At the moment, the latest estimates have the terminal rate getting to a range of 4.75%-5.00% (midpoint of 4.88%); or to a range of 5.00%-5.25% (midpoint of 5.13%); or to a range of 5.25%-5.50% (midpoint of 5.38%). With the midpoint currently at 4.63%, that would require just one more 25 bps rate hike to get to 4.88% (which means one more hike on March 22, and that's it); or two more 25 bps hikes to get to 5.13% (one in March, and one more in May); or possibly as many as three more 25 bps hikes to get to 5.38% (one in March, May and June). Either way it would appear we are closer to the end than not. And that's bullish for stocks. More . . . |
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