What Wild And Crazy Thing That No One Was Expecting Will Happen In Q2?

By Peter Tchir of Academy Securities

Fortune Favored the Bold

With stocks up over 3% last week, fortune clearly favored the bold. The commodity complex did well across the board, with WTI leading the way, up almost 10%! I could have titled this report, Being Cautious Didn’t Pay the Bills Last Week, but that doesn’t do justice to strength that we saw at the end of last week and for the entire quarter for some of the riskier segments of capital markets. ARKK is up 29% on the year and Matt Damon’s Bitcoin is up over 70% since the start of the year and 40% since early March when banking fears first hit markets. By no means have we been cautious this entire quarter, but we did enter last week advising caution and have to decide whether that is where we still want to hang our hat.

While I truly hope that I don’t have to endure a new series of Matt Damon and “Fortune Favors the Bold” commercials, I have to give a hat-tip to those who said to buy bitcoin because banks weren’t safe. I never believed that and still don’t (as a depositor), but it has played well in social media and doesn’t seem as far-fetched today as it did in February.

The MOVE Index (a measure of treasury market implied volatility) plummeted from a high of almost 200 on March 15th to 135 (128 is the 1 year average) as a semblance of normalcy returned to the treasury market. You could get up and grab a cup of coffee and not have the 2-year move 20 bps while you were briefly off the desk,

The strength in equities was likely given a boost as we had month-end and quarter-end buying, coinciding nicely with weekly and a slew of daily option expirations.

Banks

While it is time to Move Beyond Banks (where we highlight shipments, inventory and delinquencies as well as the upcoming earnings seasons) we need to start with banks.

Even after a 3% positive week for stocks none of the issues in I Know What You Did Last Winter have been resolved.

The one issue that I am watching most carefully how companies, banks and individuals respond to the divergence in short-term rates (anything from SOFR at 4.82% to T-Bills around 4.5% to bank deposits still averaging below 1%, to Bitcoin and stable coins at 0%).

This is not an “’urgent” issue, but neither is it glacier-like in its pace, which may explain why KRE (SPDR Regional Banking ETF) barely rallied in an otherwise risk-on week. If having to compete on deposit rates becomes an issue (and it might not), it would be a drag on banks, big, small and medium.

It is impressive that the broad market shrugged off ongoing risk concerns at middle size banks (based on KRE movement), but the risks mentioned last week, affecting much more than just small and midsize banks remain in the background and I suspect have a reasonable chance of being brought to the foreground again.

Inflation

I am not worried about a return to inflation fears. The PCE deflator came in below expectations (0.3%) and last month was revised down (0.5% instead of 0.6%). Yes, we went from Chair Powell discussing disinflation risks at eh first FOMC meeting of the year, to more concerns, but I remain in the camp that most of the inflationary pressures have subsided. That the Fed has already gone too far. Inflation data should help the bond market.

Jobs

The most consistent economic data of any type has been the jobs data. While other data has hinted at slowdowns, but then at rebounds, etc., the jobs data has been quite steady.

Lost in the shuffle in March, largely because of the focus on Silicon Valley Bank (which kicked off the entire banking fears), we seem to have forgotten that wage pressures looked like they were declining in the February data.

Last month, rather than our instant reaction to NFP we had to publish NFP, Debt Ceiling & Bank FUD because even on the day they were published, the jobs data was taking a back seat.

Total jobs (I’m looking for disappointment) and wage pressures (I expect continued improvement) will move markets and the two pieces of data combined will determine market direction and there is a wide range of possible outcomes (I’m in the camp that jobs will be small enough that it will ignite recession fears, but could easily see a “goldilocks” type of print), which is a range so wide, not to be of much use to anyone. Fortunately, we will have more clarity well before Friday as JOLTs and ADP come out.

The Fed

The Fed is almost done hiking (they shouldn’t have hiked last month given my view on inflation (already coming down) and concerns about lag effects of previous hike s(they clearly pushed some things/entities to the breaking point)).

I expect the Fed will have to continue to message that they will not cut rates anytime soon (I would have agreed with that message earlier in the year, but as they continue to hike, they seem to be creating conditions that could cause them to reverse course against their messaging).

Stocks as a “Long Duration” Asset Redux?

I can see where risky assets are getting a bid. The investment thesis that stocks are a long duration asset and will do incredibly well as the Fed finishes their hiking cycle is simple, has recent history on its side, which makes it compelling. Who doesn’t want to see some of these companies return to their former glory?

I just don’t think conditions are right for that sort of spike:

• Rates at 4% is far different than rates at 0%.

• Gobs and gobs of free money are not getting paid to citizens or companies unlike during COVID.

• While the Fed balance sheet grew again (as they had to lend money to banks), the large scale asset purchases, constantly sucking investible assets out of the market, has been replaced by a plan to slowly reduce the balance sheet.

• Growth had taken on a life of its own. The “bigger and better” the growth story, the better. Markets might be a little more jaded this time around.

Bottom Line

Small positive bias for bonds. The data should continue to support the bond market, though jobs remain a wildcard on that front.

Neutral to slightly bearish credit spreads. Credit spreads do tend to be tied to bank cost of funds and at the moment, I see that trending higher. Similarly, we could see some heavy issuance as companies ramp up bond sales while rates are low, spreads are decent and the Debt Ceiling and summer are fast approaching.

From slightly cautious to medium bear on equities. I could either decide I was wrong to be somewhat cautious on equities last week and get on the “breaking to new levels” bandwagon. That view has much to support it. Or, I can fade the move as discussed Thursday on Bloomberg TV, and I want to be more conservative (growing a short position) in equities here as the short squeeze (VIX spiking was an indication that real hedges had got put on, rather than just investors popping in and out of 0DTE options (which don’t count in VIX calculations) and quarter-end buying stretched what good news there was for stocks.

So what wild and crazy thing that no one was expecting will happen in Q2 2023? If you told me I would use Banks and Crisis in a sentence in Q1 on January 1st, I probably would have laughed, and yet, that’s where we got to.

Good luck and if you missed last week’s Around the World, I highly recommend catching up on it, as the geopolitical issues and risks are not going away.