Make no mistake, Powell wanted the banks to cut lending
He’s also an economic history student and definitely knew something was going to explode in some corner of the financial world. Indeed most commentators said Powell would keep raising until something broke. Something pretty big has broken here and there in Europe. The surprise was a very fast growing bank that got so big it became systemic. Powell probably didn’t imagine that would happen. It turned out that at Silicon Valley Bank (SIVB). I won’t go into detail about their negligence, you’ve probably heard about it, and First Republic (FRC), I’m not here to bore you any more than necessary. As far as Europe Credit Suisse (CS) And Deutsche Bank (DB), were, unintentionally, of course, serial troublemakers. If we get through this afternoon with no news of a new regional bank going up in smoke, I think we can put this little episode behind us.
If Powell knew he was going to blow something up in the financial sector, why did he do it and raise rates so quickly?
The answer to both is that he had to, in order to smother the embers of rising prices and turn them into a wage-price spiral. This is also why he wants to suppress jobs, fewer jobs equals lower wages, breaking this cycle by reducing demand. The Fed’s rate hike is the only tool it has to fight inflation, and unfortunately it is a very blunt tool.
What I would like to say about higher interest rates is that they disrupt banks’ investment strategy. The Fed did this even if it would make shareholders, bank managers and depositors very uncomfortable, which is really what the Fed wanted all along. He raised interest rates so his T-bills and bonds would compete with other investments and drain liquidity from the system. This in turn would dampen demand for credit and make credit more expensive even if you get one.
What is liquidity anyway?
A word on liquidity making the rounds in the financial news: We’re talking about “real economy” liquidity here. Bank credit 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 for money going to borrowers. Not being able to afford a mortgage on your home or the trade credit to fund your inventory is at the heart of the matter. The medium and small businesses (SMEs) on Main Street are likely to find themselves in a world of doom as the banks pull back their loans. SMBs are 50% to +60% of America’s business engine. SMBs take on a majority of the new hires and need to stop the new hires and might even start laying off employees. Unfortunately, the only tool the Fed has is to hike interest rates. On the other hand, Powell has the power of the tyrant pulpit and could begin to propose that government spending expansion should be curtailed in order to defeat inflation. I hope he does it privately. I am not writing this as politics, just to explain Powell’s sharp reversal and strong anti-inflationary campaign that he has waged. So even if he faces what appears to be a banking crisis, he won’t give up on rising rates, instead nullifying Powell’s return to a 0.50% hike, prompting a 0.25% hike instead. That said, it’s likely Powell will do another one and be done. Frankly, 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 of deficit spending will only exacerbate the demand side and keep inflation stubborn.
Why a rally now?
Believe it or not, we’re already gathering. The Nasdaq is up 12% year-to-date through Friday’s close and the S&P 500 is also up 3.4%. Of course, they still have a long way to go to pull us out of the bear market that we are technically still in (20% from the previous high). So that means that this will be another “bear market” rally.
Whether the regional banking crisis is Jamie Dimon’s “hurricane” or a storm in the teapot, it’s 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 see another bear market rally like we had in January. Could it be the start of the “real rally”? I don’t think so, as we will see the effects of the business slowdown when lending is finally and quickly removed from the economy and ‘variable monetary policy lags’ finally come into play. Will it be a steep recession? I’m still on the side for now a mild and short recession.It will likely be the stated policy that the regime of rising interest rates will not be over, but it will be quite slowed down until it fully recedes.The market looking to 2024 and seeing an economy without Fed interference , will make a strong recovery.
There’s a mild pattern that doesn’t always show, but we had blown tops in March. This means such a dizzying move higher that it becomes completely unsustainable and when everyone rushes to the exits, it eventually crashes onto the calmer uptrend or even the lows of the trading range.
Ok, but why would the market recover with all this bad stuff ahead?
There really is a simple but powerful reason – Powell is finally going to spin! That’s it. It’s also good that this banking crisis isn’t really a big crisis. I feel that message was sent loud and clear as stocks shrugged off the recent banking scandal involving Deutsche Bank and ended up closing higher. Most market analysts warned that the market should not want a pivot (in this case, it meant a rate cut). because that meant we were in a recession. For our purposes, this “Fed Pivot” – halting the rate hike regime – is something to celebrate! Of course, the first step in lowering rates is for the Fed to stop raising rates, but that’s another discussion. Market participants don’t need to worry about higher interest rates, and homebuyers can plan for the future now, knowing that interest rates will remain. All this benefits everyday financial life. Once interest rates stabilize, banks will start lending again, but at higher interest rates and a little more frugally. However, the sooner the Fed gets out of our way, the sooner the economy and our stock market can function as they should.
So right now the rally is being led by big cap technology, I think it’s expanding
If this is going to be a multi-week march to the upside, I expect the “big tech” rally to spread to smaller tech companies that have taken steps to turn a profit or at least become cash flow positive. Industrial companies should be part of the parade, especially aerospace and defense; I have held a number of positions since my last writing. 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) had. Because I believe that small and medium-sized businesses will look for other ways to get finance, I started a job at American Express (AXP). When it comes to looking for bargains in the fear of banks, I picked up Charles Schwab (SCHW). This was a controversial name in the Dual Mind community, with most members even considering it too risky to trade. I think if I keep 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 series of calls through June. I’ve already fallen 25%. So maybe let these pass. I bought First Republic Bank (FRC) but immediately changed my mind. I grabbed New York Community Bancorp (NYCB), I was in it before they made (or should I say steal) this deal with the FDIC by buying the deposits and they had their choice of loan portfolios on top of that. They left Signature Bank with the FDIC so they wouldn’t have to worry about any bad things that might have happened at the bank. I think we have bottomed out in hydrocarbons so oil refiners like Phillips 66 (PSX) and HF Sinclair (DINO) are the best sector to invest in now. I also think that acquisitions have picked up, I think it’s really going back to a sustained faster pace, especially in biotech. The FTC doesn’t seem to care if small biotechs get eaten by big pharma, so I suspect the investment bankers will spend a lot of time arranging marriages there.
I’m late to the party, but I’ve started shorting trading office REITs
About $270 billion in bank commercial mortgages will expire this year, and $1.4 trillion over the next five years. The terms they set will likely lead to the foreclosure of some buildings. I have shorted Boston Properties (BXP) and SL Green (SLG). I have a little buyer regret, like I said, I’ll be late to the party. Then maybe wait until they’re up 10%, or better yet, laugh at my expense and put your money elsewhere.
This week’s schedule
Monday-Tuesday UBS’s bailout of Credit Suisse was a salve against fears of contagion from the European bank that led to big gains in the market
Wednesday – FOMC hike of 0.25% instead of the 0.50% it had cabled just 2 weeks earlier until the Silicon Valley bank failed on March 10, sparking the region’s banking woes. Also, Powell hinted that there might only be one more, and that would be it. Goldman Sachs lowers GDP forecast due to stress at small banks. Yellen appeared to back down on securing all accounts. The final stretch turned the rally into a defeat.
With no banking news, the market continued its uptrend on Thursday.
Friday – We had the news that DB was in trouble. First the futures market fell sharply, then we rallied. Market message is forget the banks Powell Pivoted! Market participants need to celebrate that. Despite protests, the bond market is telling us rates will be cut in 2023.
So let’s celebrate this slight bank angst and hope the next thing that happens is May when we’re all supposed to be walking away anyway.
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