A Sharp Rally Is Being Masked By A Minor Bank Crisis, Opportunities, And Dangers
- Don't let the regional bank scare, scare you away from the rally.
- I may be overly optimistic, but there is a chance that we could have another January-type bear market rally.
- Just be aware of where the exit is when the party ends in a panic. The signs will be there.
- The next shoe to drop might be in commercial offices, so I am short two REITs via Puts. REITs that own B and C-level offices may have a number of foreclosures to deal with.
- This idea was discussed in more depth with members of my private investing community, Dual Mind Research. Learn More »
Make no mistake Powell wanted the banks to pull back on lending
He is also a student of economic history and definitely knew that in some corner of the financial world, something would blow up. In fact, most commentators were saying that Powell would keep raising until something broke. Something pretty big broke here and then in Europe. The surprise was a very fast-growing bank, that got so big that it became systemic. Powell was probably not imagining that would happen. It turns out some dumb stuff was going on at Silicon Valley Bank (SIVB). I'm not going into details about their negligence you probably heard about that, and First Republic (FRC), I'm not here to bore you more than is necessary. As far as Europe Credit Suisse (CS) and Deutsche Bank (DB), have been serial troublemakers, unintentionally of course. So far if we get through this afternoon without some news of a new regional bank going up in smoke, I think we can put this little episode behind us.
If Powell knew he would blow something up in the financial sector, why did he do it and raise rates so fast?
The answer to both is that he had to, in order to choke off the embers of rising prices and turn it into a wage/price spiral. This is also why he wants to suppress jobs, less jobs equal lower wages which breaks that cycle by lowering demand. The Fed raising rates is the only tool it has to battle inflation, and unfortunately, it is a very blunt instrument.
The point I would like to make about higher rates is that it disrupts banks' investment strategy. The Fed did this even if it was going to become very inconvenient for shareholders, bank executives, and depositors, this is really what the Fed wanted all along. He raised rates so that its T-Bills and Bonds would compete with other investments and drain liquidity from the system. This in turn would depress demand for loans, making loans more expensive even if you got one.
What is liquidity anyway?
A word about liquidity that is bandied about in financial news: this is the "real economy" liquidity we are talking about. Bank lending is the lifeblood of our economy, and the drying up of the stock market and even corporate bonds is more of a canary in the coal mine, to money going out to borrowers. Not being able to afford a home mortgage or the commercial credit to fund your inventory is the heart of the matter. The medium and small businesses (SMBs) on Mainstreet are likely to come into a world of hurt as banks pull back on credit. SMBs are 50% to +60% of the business engine of the USA. SMBs doing much of the hiring and will have to stop hiring and might even start laying off workers. Unfortunately, the only tool the Fed has is raising rates. On the other hand, Powell does have the power of the bully-pulpit and could start suggesting that the expansion of government spending should be curtailed to defeat inflation. I hope he is already doing this privately. I am not writing this as politics, but only as an explanation for Powell's sharp reversal and strong anti-inflation campaign, he has been on. So even as he is confronted with what seems to be a banking crisis, he is not going to abandon rising rates Powell instead nixes his return to a .50% rise but makes the .25% rise instead. That said it is likely that Powell will do one more and be done. Honestly, there are two ways to control inflation Powell has done all he can monetarily it's time to start working on the fiscal side. Flooding the economy with so many dollars in deficit spending will only exacerbate the demand side, and keep inflation stubborn.
Why a rally now?
Believe it or not, we're already rallying. The Nasdaq has made a 12% year-to-date gain through Friday's close and the S&P 500 is up +3.4% as well. Of course, they have a way to go to get us out of the bear market we are technically (20% from the previous high) still in. So that means this will once again be a "bear market" rally.
Whether the regional bank crisis is Jamie Dimon's "Hurricane" or a tempest in a teapot, it is still a shot across the bow for the Fed. The Fed will likely have to start the end-game sooner rather than later. I think we will have another bear market rally as we had in January. Could it be the start of the "real rally? I don't think so, because we will see the effects of the business slowdown as credit is finally and rapidly removed from the economy. This is the much-ballyhooed claim of "long and variable lags of monetary policy" finally coming to fruition. Will it become a steep recession? I am still on the side of a mild and short recession right now. It will likely be the stated policy that the rising rate regime will not be over, but it will be slowed quite a bit until it recedes completely. The market looking into 2024 and seeing an economy free of Fed interference will rally sharply.
There is a mild pattern that doesn't always show itself but we have had blown-off tops in March. This means such vertiginously sharp upward movement that it becomes totally unsustainable and as everyone rushes for the exits it slams down to at last the more placid uptrend or even to the lows of the trading range.
Ok, but why should the market rally with all this bad stuff in front of us?
There is really one simple but powerful reason - Powell is finally going to pivot! That is it. Well also that this bank crisis really isn't much of a crisis. I feel that this message was broadcast loud and clear when stocks shrugged off the latest bank scandal with Deutsche Bank and ended up closing higher, Most market analysts were warning that the market should not wish for a pivot (in this case it meant lowering rates) because that meant we were in a recession. For our purposes, this "Fed Pivot" - stopping the rate rise regime is something to celebrate! Of course, the first step to cutting rates is for the Fed to stop raising, but that is another discussion. Market participants not having to worry about higher rates, and home buyers now will be able to plan for the future knowing that rates will remain in place. This is all beneficial to everyday financial life. Once interest rates are stabilized banks will lend again, but at higher rates, and also a bit more sparingly. However, the sooner that the Fed gets out of our way the sooner the economy and our stock market can function the way it is supposed to.
So right now the rally is being led by big-cap tech, I think it broadens
If this will be a multi-week march higher I expect the rally to spread out from the "Big Tech" to smaller tech that has taken steps to get close to profits or at least cash flow positive. Industrials should be part of the parade, especially aerospace, and defense; I've started a number of positions since my last missive they are; Ingersoll Rand (IR), Commercial Metal Company (CMC), Terex (TEX). I still have CNH Industrial (CNHI), and all the aerospace names I had before Boeing (BA), General Electric (GE), AeroVironment (AVAV), Raytheon (RTX), Spirit Aero (SPR), Textron (TXT). Since I believe Small and Medium Sized businesses are going to look for other ways to get funded, I started a position at American Express (AXP). As far as looking for bargains in the banking scare I picked up Charles Schwab (SCHW). This was a controversial name in the Dual Mind Community, most members thought it was too risky even for a trade. I think that if I hold it for a year, I will be very happy to own it. The low was $45, which happens to be the 52-week low, and the last tranche I bought was $51.76. I also have a number of calls out to June I am already down 25%. So perhaps let this one pass. I did buy First Republic Bank (FRC) but thought better of it immediately. I snagged New York Community Bancorp (NYCB), I was in it before they did that deal with the FDIC (or should I say steal) by buying the deposits and they had their pick of the loan portfolio to boot. They left the Signature Bank with the FDIC so they don't have to worry about any bad stuff that might have gone on at the bank. I think that we've seen the bottom in hydrocarbons so the best sector to get involved with right now are the Oil refiners like Phillips 66 (PSX), and HF Sinclair (DINO). I also think acquisitions have been increasing, I think it really gets back to a sustained higher pace, especially in Biotech. The FTC doesn't seem to care when small biotechs get eaten by big pharma, so I get the investment bankers will spend a lot of time arranging marriages there.
I'm late to the party but I started shorting commercial office REITs
This year, roughly $270 billion in commercial mortgages held by banks are set to expire, and $1.4 trillion over the next five years. The terms they set will likely cause some buildings to be foreclosed. I shorted Boston Properties (BXP) & SL Green (SLG). I have a little buyer's remorse like I said I'm coming late to the party. Wait for them to go up 10% then maybe, or better yet have a chuckle at my expense and put your money elsewhere.
This week's timeline
Monday-Tuesday The UBS bailout of Credit Suisse was a salve to the fear of European Bank contagion that led to big gains in the market
Wednesday - FOMC raise of .25% instead of .50% he had telegraphed just 2 weeks earlier, until Silicon Valley Bank failed on March 10, kicking off the regional bank troubles. Also, Powell indicated that there might be just one more and that would be it. Goldman Sachs cuts GDP forecast because of stress on small banks. Yellen seemed to backpedal on ensuring all accounts. That last piece is what turned the rally into a rout.
Thursday with no banking news the market resumed its upward climb.
Friday - We had news that DB was in trouble. At first, the market dropped with the Futures down heavily then we rallied. The message of the market is to forget the banks Powell Pivoted! Market participants need to celebrate this. Also despite protestations the bond market is telling us that rates will be cut in 2023.
So let us celebrate this mild banking scare, and hope the next thing that breaks happens in May when we are all supposed to go away anyway.
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