Wentz Weekly Insights
Rates Rise, Stocks Fall With Banking Concerns Returning

US stocks were down nearly 3% last week until Friday’s rebound after solid earnings from the world’s most valuable company Apple, driven by strength in international markets like India, and another stronger than expected labor report. Driving stocks lower the first half of the week was additional concerns from the banking sector. This came after reports that regional bank PacWest was looking to sell itself, similar to what happen prior to Silicon Valley Bank, and more recently First Republic Bank, failing. Deposits at commercial banks have fallen nearly $1 trillion since peaking last year, crippling liquidity positions at some smaller banks. With the selloff in the regional banks (the average regional bank stock down 35% since March), we do think there will be opportunity, but it may still be too early.
The other headline mid-week was the FOMC meeting where it concluded with another 25 basis point (0.25%) increase to the Federal Funds rate, increasing the target range to 5.00% – 5.25%. This was widely expected, but investors wanted to know how Powell and co. would telegraph a pause in rate increases moving forward. The policy statement states it no longer “anticipates that some additional policy firming will be appropriate” and replaced it with “in determining the extent to which” additional policy tightening will be appropriate, essentially paving the way for a pause.
However, it has been meetings now that the Fed Chairman Powell has ended up coming out of the FOMC meeting more hawkish than the market and strategists were expecting, each time sending stocks lower. The statement and Powell’s comments did not provide language that suggest a pause would be as certain as what most were expecting, with Powell adding the FOMC will “be driven by incoming data, meeting by meeting.” In addition, Powell dismissed the probability of the Fed cutting rates this year when asked about the markets still expecting (pricing in via futures bets) three rate cuts.
Regarding the banking issues, he said credit tightening “will” happen rather than it is a “probability” and that we may see the extent of this in the next Senior Loan Officer Opinion Survey (released this week).
Another important point is Powell for the first time indicated that, with the combination of real interest rates that are above the estimated neutral rate, its balance sheet reduction program (quantitative tightening), and credit tightening from the banking crisis, policy is “possibly at that level” of a restrictive stance. A restrictive stance is opposite of an accommodative stance in that it means policy is tight enough to where it slows the economy and constricts spending.
Powell mentioned he does not believe the economy will slip into a recession, differing from many views including the Fed staff. Employment data last week suggest we may be starting to see some weakening though, especially when it comes to the labor market. The number of job openings fell to 9.6 million, still a high number, but falling 2.47 million from the highs and the lowest since 2021. In addition, weekly jobless claims have trended upward, averaging 240,000 over the past four weeks, up from 200,000 several months ago. While these numbers are weaker, they are still not at historically normal (pre-pandemic) levels.
However, it is a mixed picture. The Department of Labor’s monthly employment report showed a stronger than expected 253,000 job gains in April. While this is better than the 180,000 expected, job gains have averaged 222,000 over the past three months, down from the average of 334,000 over the prior three month period. The tightness in the labor market can be seen by the number of people unemployed of 5.66 million at the lowest levels since 2000. With the labor markets remaining tight, the Fed will keep its focus on inflation and bringing that down to its target of 2%. We will see the latest inflation data this Wednesday with the consumer price index.
As mentioned in last week’s newsletter, the upside momentum markets have experienced has been led by a narrow group of names, while overall market breadth has been weak. For example, nearly all of the S&P 500’s 7.7% return this year has been driven by the 10 largest companies (think names like Apple, Facebook, Tesla, Nvidia), whereas the average stock is up less than 1% this year. We are skeptical on the rally in stocks recently, and continue to prefer a defensive overweight in portfolios.
Week in Review:
Stocks opened the week on Monday positive, trading in positive territory for most of the day before a late day selloff had stocks ending lower. Morning news was dominated by the banking sector after JPMorgan agreed to acquire most of failed bank First Republic Bank’s assets and loans. Stocks reversed shortly after they nearly touched the highs of the year and after a letter from Treasury Secretary Yellen was sent to Congressional leaders saying the Treasury will exhaust its funds as early as June 1. Data in the morning was focused on manufacturing survey results, which were slightly better than expected but still suggest declining activity while prices reaccelerated recently. Yields on Treasuries saw a large move higher with the 10-year up 14 bps to 3.58% while the S&P 500 finished down just 0.04%.
Regional banks led the markets lower on Tuesday over additional banking fears after First Republic Banks failure with the Regional Banking stocks down 6.3%. Economic growth concerns were back after job openings fell to the lowest level since April 2021 with layoffs the highest since late 2020, although that would be a welcoming sign to the Fed. After Monday’s move higher, Treasuries yields fell with the S&P 500 finishing down 1.16% and small caps the clear underperformer with the Russell 2000 down 2.10%.
Stocks were unchanged on Wednesday for most of the day until the afternoon’s FOMC announcement on raising rates another 25 basis points. The big move lower was after Chairman Powell’s press conference which was more hawkish in that Powell suggested a pause in rate increases was not as certain as what markets were expecting, while pushing back against the market’s expectation of three rate cuts by year end because the inflation outlook does not warrant rate cuts. There were several key earnings reports, with AMD and CVS posting solid quarters but weak guidance while Starbucks was positive all around. Treasury yields moved lower, particularly on the short end with the Fed sensitive 2-year yield falling 15 basis points to 3.83% while stocks finished lower across the board with the S&P 500 down 0.70%.
Stocks were lower to start the day again on Thursday, but this time due to banking issues making their way back to headlines. Overnight regional banks were much lower after PacWest said it was weighing strategic options including on outright sale, while TD Bank and First Horizon moved forward to terminate their merger agreement. Morning data included jobless claims that held steady, a trade deficit that narrowed in March (positive for Q1 GDP), and productivity that fell in the first quarter, a negative for future economic growth. Overseas, the European Central Bank and several other central banks tightened policy further by raising interest rates again and signaled further rate increases. Stocks ended lower across the board again with Treasuries higher as yields fell significantly on the short end over additional banking and economic fears. The S&P 500 fell 0.72% while small caps continued to underperform with the Russell 2000 down 1.18%.
Markets were higher Friday after a positive Apple earnings report driven by emerging markets like India, although its guidance was weak, and a solid labor report showing more hiring in April than expected with further wage growth, alleviating growth concerns. Stocks had a strong session with small caps up 2.4% while the S&P 500 rose 1.85%.
US stocks fell for most of the week but had a solid day on Friday after the labor report. Growth outperformed value through the week thanks to tech, with the major US indices finishing the week as follows: NASDAQ +0.07%, Russell 2000 -0.51%, S&P 500 -0.80%, Dow -1.24%.
Treasuries saw a volatile week, particularly the Fed sensitive 2-year Treasury, the yield of which fell just 9 basis points from start to finish, but traded in a range of 50 basis points and as low as 3.66%, the lowest since September, and finishing at 3.91% while the 10-year yield was more stable, finishing at 3.44%.
After rising for four consecutive weeks after the OPEC decision to cut oil production, crude oil fell 7.1% last week for the third straight weekly decline as the rebound in China demand was not as strong as investors thought it would be as well as concerns over future growth, with Bloomberg reporting speculators’ share of open interest is at the lowest point in three years (during the onset of the pandemic).
Also of note, gold reached a new high of $2,060/oz amid the banking turmoil and economic concerns.

Recent Economic Data

  • The index on the PMI manufacturing survey was 50.2 for April, reflecting a slight improvement in manufacturing conditions during the month, and was up from being in contraction territory in March at 49.2. Survey respondents noted client demand remained muted as inflation concerns remained apparent. Output and production improved and with the anticipation of improving future sales, employment picked up with the fastest job creation since September. The general conditions index at 50.2 was the best since October and first in expansion (over 50) in six months.
  • The index on the ISM manufacturing survey was 47.1, suggesting manufacturing activity continues to decline, now the sixth consecutive month of declines, but at a slower pace than March’s index level of 46.3. New orders declined further while customer inventories increased which is a negative for future production. Respondents noted near equal levels of activity for employment amid mixed sentiment on when growth will pick back up. Prices continue to pick up and have trended upwards since December, something worth keeping an eye on.
  • Factory orders were up 0.9% in April, versus the 1.3% increase expected and follows a -1.1% (revised downward from -0.7%) in March. Excluding transportation, which is volatile due to the large dollar of aircraft orders, orders were weak, declining 0.7%. Core capital goods orders excluding aircraft, which is a proxy for capital spending and more of an input to GDP, was down 0.6% for the worst month since May 2021.
  • In April the number of vehicles sold rose 1.1 million compared to March to an annual rate of 15.9 million vehicles. This is the second highest sales pace since May 2021 (the only month higher was January at 16.0 million). However, the sales pace is still well below pre-pandemic levels of around 17 million.
  • Construction spending rose 0.3% in March to a seasonally adjusted annual rate of $1,834.7 billion and is 3.8% higher from 12 months earlier. Residential construction spending was down another 0.2% for the tenth consecutive monthly decline, now down 9.8% from a year earlier and down 12.3% from the peak in May 2022, while non-residential construction spending was up 0.7% and up a strong 18.8% from a year ago.
  • The ISM survey on non-manufacturing (services) activity showed conditions expanded for the fourth consecutive month, after a small decline in December which was the first decline since the onset of Covid. The index was 51.9 for April, up slightly from 51.2 in March (anything over 50 is expanding conditions) with 14 of the 18 major industries reporting growth. New orders accelerated while the price index remains elevated and inventories contracted for the second consecutive month.
  • The trade deficit improved in March, with the US having a deficit of $64.2 billion in the month, down from the $70.6 deficit in February. This will be a net benefit to GDP which will likely revise Q1 GDP slightly higher. However, it is not all that positive. Imports fell $1.1 billion, or 0.3% signaling domestic demand is softening, while exports saw a 2.1% increase, or by $5.3 billion. In the first quarter imports fell 1.6% while exports increased 8.7% resulting in a 28% decline in the deficit compared to Q1 2022.
  • US worker productivity, one of the main drivers of longer term economic growth, declined by 2.7% in the first quarter, on an annualized basis, and is much worse than no change that was expected and follows a 1.6% increase in productivity in Q4. The decline was due to a 3.0% increase in the amount of hours worked offset by just a 0.2% increase in output. Compared to Q1 2022, productivity was down 0.9% reflecting a 1.3% increase in output and a 2.3% increase in hours worked. This marks a record fifth consecutive quarter of year-over-year declines in productivity, not a good sign for upcoming growth. Meanwhile unit labor costs increased a much more than expected 6.3% annualized, reflecting a 3.4% increase in compensation and the 2.7% decline in productivity. Very disappointing report.
  • The number of job openings in March fell 384k to 9.590 million for the lowest number of openings since April 2021, and lower than the expectation of 9.700 million. The number of quits remains high and was little changed month-over-month at 3.9 million. However, the number of layoffs rose 248k to 1.8 million for the highest since December 2020.
  • The number of jobless claims for the week ended April 29 increased 13k to 242,000 with the four-week average rising 3.5k to 239,250. The number of continuing claims fell 38k to 1.805 million with the four-week average down slightly to 1.828 million, falling about 55k from its two-year high two weeks ago.
  • ADP reported it saw payroll gains of 296,000 in April, a very solid number that beat expectations of 140,000 and doubling the gains made in March. The ADP Chief Economist noted there was a slowdown in pay growth as employers hold back on pay gains with more workers coming off the sidelines, while data is showing fewer people are switching jobs. Job gains were seen in all sized businesses, but sector-wise, manufacturing saw a large decline again.
  • The DOL reported a gain of 253,000 payrolls in April, according to its establishment survey, indicating job growth was stronger than the roughly 180,000 gains that were widely expected. However, the previous two months were revised down by a sizeable amount – February was revised down 78k to 248k while March was revised down 71k to 165k. Job growth has averaged 222k over the past three months compared to the average of 334k the previous three-month period. The most gains came from professional/business services, health care, leisure/hospitality, and social assistance, with no major sectors seeing a decline. The average workweek was unchanged at 34.4 hours. Also, wage growth jumped to a 0.5% increase in March, well above expectations with wages up 4.4% over the past year (accelerating from 4.2% y/y in March), and are up 16.8% from pre-covid levels. If this stays high, the concern will move from supply/demand imbalance causing inflation, to wage inflation causing inflation so worth keeping an eye on. Now based on household survey data, the labor force fell slightly by 43k to 166,688 million while the number of people employed increased 139k to 161,031 million, and the number unemployed declined 182k to 5.657 million, the lowest since December 2000 when the labor force was 23 million people less. This caused the unemployment rate to fall to 3.4% from 3.5% and the U-6 rate fell to 6.6% from 6.7%. It was another solid employment report and markets did not move much afterwards, suggesting it saw this as evidence for a “soft landing” scenario.

Company News

  • Restaurant group Darden Restaurants (operator of Longhorn, Olive Garden, Bahama Breeze, etc) said it will acquire Ruth’s Hospitality Group, an operator of steakhouses, for $21.50/share, or $715 million, a 34% premium to where it traded to prior to the announcement.
  • Johnson & Johnson completed the spin off of its consumer products division Kenvue via an initial public offering (IPO) late last week. The division includes popular products such as Benadryl, Tylenol, Band-Aid, Aveeno, Listerine, and Nicorette. The IPO raised $3.8 billion making it the largest IPO since 2021 and was well received, with shares rising 22% after opening for trading.
  • A report by Bloomberg said Microsoft is working with AMD on its expansion into artificial intelligence (AI) chip processors. The work is part of an effort to secure more of the components and the companies are teaming up to offer an alternative to Nvidia which dominates the AI chip market. The report says Microsoft is providing engineering resources to bolster its efforts while working with AMD on building its own processor for AI, going by the code name Athena. Later in the week, Microsoft denied the report.
  • Shortly after several reports that media company Vice Media was preparing to file for bankruptcy, the WSJ reported Vice is in talks to sell itself out of chapter 11 bankruptcy by selling to its top lenders through a reorganization which would wipe out its investors. The planned sale to the lenders would value Vice around $400 million, a fraction of its peak valuation of $5.7 billion in 2017.

Other News

  • On the debt ceiling fight, both Republicans and Democrats have reportedly rejected the possibility of a short term debt ceiling increase, which would provide Congressional leaders with more time for negotiating a longer term solution. However, NBC is reporting the White House has recently considered whether to negotiate a short-term deal to keep the government funded. Meanwhile, Republicans have been skeptical of the (as early as) June 1st date when the Treasury will run out of money, per the Treasury Secretary Janet Yellen. She warned there will be “economic chaos” if Congress fails to act. With Congress currently on recess, President Biden invited Congressional leaders to the White House this Tuesday for a meeting to discuss the debt ceiling. Regarding a deal, Senator McConnell (R-KY) said he will not agree to a deal that fails to make “substantive spending and budget reforms.”
  • The interest rate on Series I Savings Bonds, I Bonds for short, will decline to 4.3% for the next six month period, down from 6.89% in the previous six months and down from this cycle’s peak of 9.62% this period last year. Series I Bonds gained attention last year due to the interest rate being tied to inflation (CPI index), which reset twice a year (May/November), and the attractive rate it was generating due to 40-year high inflation. The new rate is better than the 3.8% that some were expecting.
  • The Federal Deposit Insurance Corp (FDIC) is reportedly planning to release a proposal to replenish the Deposit Insurance Fund, which took a hit after the recent banking failures. The proposal would include the larger banks paying a small fee while smaller banks would be exempt from the fee. The largest banks would end up paying higher fees but will be based on the number of depositors and size of its balance sheet.
  • Last week Russia alleged that Ukraine staged a drone attack by sending two drones to the Kremlin to attack/kill Putin at his residence, where they say he was not in the building at the time. This could very well create a justification for Russia to escalate its attack on Ukraine.
  • The World Health Organization said it ended the global health emergency declaration for Covid on Friday, although Covid will continue to have a pandemic status. WHO Director Ghebreyesus said the pandemic has been on a declining trajectory with population immunity growing and infection and mortality declining. Meanwhile, the US is set to lift the Covid health emergency on May 11.
  • Central Bank updates
  • The Reserve Bank of Australia made a surprise 25 basis point increase to policy rates early last week, despite its previous attempt to pause rate increases. It said inflation is past its peak but at 7% is still too high and justifies more rate increases, adding if high inflation became entrenched in expectations it would be even more costly to reduce later involving even higher rates and a larger rise in unemployment (similar comments to Powell that doing too little is potentially more damaging that doing too much).
  • The European Central Bank raises interest rates 25 basis points as expected, there was even a small speculation they would raise 50 bps. It said inflation has been too high for too long and price pressures remain strong. It also called on European leaders to roll back energy subsidies.
  • Elsewhere, Hong Kong and Norway’s central banks raise rates 25 basis points.

Did You Know…?

Bank Deposit Outflow, Money Market Inflows

Bank deposits have been a large area of focus this year after the first bank failure since 2020 when Silicon Valley Bank went under in March. SVB’s mismanagement with the risk profile of its securities (mainly holding longer dated Treasuries that dropped significantly in value) caused a liquidity crunch and after it failed, other regional banks began to see deposit outflows accelerate. Data shows deposits at US commercial banks, which includes all US chartered banks, have fallen by 5.5% or $990 billion since peaking in April 2022. To make matters worse, over half of that decline has occurred since SVB’s collapse, the largest 2 month decline ever, and a majority of those outflows have occurred at the smaller, regional banks, hence the 15% decline last week in regional bank stocks and 37% decline since March 1st. Alternatively, money market fund assets have increased by $800 billion since April 2022, a 18% increase over that period. With the Federal Reserve raising interest rates again, money market rates are now over 5% with the reverse repo facility paying 5.05%.

The Week Ahead

Earnings releases will continue, economic calendar is lighter though will include important inflation data, while the debt ceiling debate heats up this week. There will be another group of companies reporting quarterly results this week, including many smaller tech names, with notable results coming from PayPal, Tyson Foods on Monday; Airbnb, Fox, Electronic Arts, Occidental Petroleum on Tuesday; Disney, Trade Desk, Roblox, Toyota on Wednesday; JD.com, Honda, Tapestry on Thursday; and Spectrum on Friday. Investors will be focused for the release of the Fed Senior Loan Officer Opinion Survey on Bank Lending Practices this week, something Powell referred to in the past FOMC meeting, for any indication on how much credit tightening we have seen in the banking industry over the past several weeks. The consumer price index on Wednesday will be the most notable economic data releases this week with the consensus seeing a 0.4% increase in prices in the month, accelerating from a 0.1% increase in March due to a small rise in energy and core prices. Elsewhere, jobless claims are release Thursday along with the producer price index, and import and export prices and consumer sentiment come out Friday. Politics will remain in focus as well as we get closer to the debt ceiling deadline. White House leaders are expected to meet with Congressional leaders on Tuesday to negotiate a best path forward where a short term funding is looking more likely.