Wentz Weekly Insights
 The Confidence Crisis & How It Impacts This Week’s Fed Decision

Headlines on the current banking issues are extremely fluid and in this environment things can change quickly and markets moves can be extreme. This was reflected in the volatility index (the VIX) last week, which surged from recent lows in the 18 range to a recent high of near 31, the highest since stocks last bottomed in October. Stocks were on a roller coaster ride last week, beginning Monday up, then down, then up, then down, and finishing Friday up for a net gain for the week, while Treasury yields did the same but were well lower for the week.
The banking issues that started with Silicon Valley Bank (SVB) spread to other regional banks last week and even spread across the world to Swiss bank Credit Suisse. The issues may have started with managing interest rate risk but is now turning into a confidence crisis as deposit outflows pick up pace. Triggering the collapse of SVB and Signature Bank was customer outflows of deposits that started to affect their liquidity positions. Banks borrow money from customers, paying a small interest rate, and make money by lending that cash to others at a higher interest rate. As individuals and businesses began to realize they could get a higher interest rate on their cash rather than leaving it as deposits in banks, such as money market instruments, outflows accelerated.
Banks hold a large investment portfolio for liquidity and interest income. A select few banks held a bond portfolio in securities that had longer maturities. As rates go up, the longer maturity bonds fall more than bonds with short maturities because investors could buy new bonds with the same maturity that pays a higher rate. As deposit outflows accelerated, liquidity positions at many banks deteriorated. This was made worse at several bank who had a longer maturing portfolios who were forced to sell bond portfolios at a substantial loss.
With two banks failing in a short period of time, the confidence in the banking system tumbled which caused a further increase in deposit outflow – away from the smaller, regional banks, and to the large “too big to fail” banks. This is a reason we are seeing the issue persist and why the FDIC, Fed, and Treasury stepped in to guarantee deposits at these banks.
While banking issues were spread beyond Silicon Valley Bank (SVB) last week, it is apparent there is a wide display of support for the sector after decisive moves were taken; the Treasury and Federal Reserve protecting depositors at select regions banks (even beyond the FDIC insured deposits), the Fed opening lending facilities for banks in need of liquidity, Swiss National Bank providing support for Credit Suisse, a group of banks providing $30 billion in capital to First Republic Bank, and UBS coming in to acquire Credit Suisse.
While this is happening, there is another important debate going on. That will be addressed this week after the Federal Open Market Committee (FOMC) of the Federal Reserve meets and announces its next move on monetary policy.
The Fed wants to hike interest rates, but the question is will they be able to. We believe the decision will come right before the announcement as the Fed wants to be confident there is stability in the financial system. We think if it were not for the failure of the three banks, it would have preferred to raise rates 50 basis points (bps, one equals 1/100 of one percent), and this is what the market believed as well. Before the bank failures, the markets were putting a 70% probability we would see a 50 bps hike, and just a 30% chance there would be a smaller 25 bps hike, based on the pricing of futures contracts. However, the probability of a 50 bps hike fell to 0% last week, whereas the probability of a 25 bps hike is at 60% and the probability of no change is 40%.
We think the Fed will raise rates 25 bps on Wednesday at 2:00pm in effort to keep its credibility and maintain its tough message on inflation. The bigger question and what market participants should be more focused on is the summary of economic projections (SEP) and the “dot plot.” This shows where policymakers see rates at the end of the year, next year, and over the longer-term. Policymakers will also update their projections on economic growth, inflation, and employment. As we said after the last meeting, the worry is no longer how fast rates will rise, or even how high they will rise, but rather how long they will stay high. The new SEPs will provide us greater detail on this question.
Lately, the expectation is that rates will be cut by time the year rolls over. This was not the expectation two weeks ago. Futures pricing is showing investors think the Fed will end up cutting rates by 2% by the January 2024 meeting, a considerable difference from two weeks ago when the markets expected rates near 5.5% at that time (which would equal no cuts).
What has that meant for markets? It means shorter-term Treasuries and growth stocks have rallied. Growth investors prefer lower rates because most of the profits are expected to be generated in the future and a lower rate gives them a higher valuation, in addition to the cost of doing business falling. If investors think rates will head lower soon, they will buy growth stocks in anticipation of that move. Treasury yields have fallen because investors are now believing the Fed will be forced to cut rates by summer. The two-year Treasury note is most sensitive to Fed policy, and its yield has fallen from a 16-year high of 5.10% right before the issues with SVB emerged two weeks ago, to a recent low of 3.78% (closing Friday at 3.83%). When yields fall, the price of the bond rises. The Treasury sensitive to the longer-term economy is the 10-year Note and its yield has fallen from a 4.10% to a recent low of 3.37%.
While markets have priced in the expectation of several rate cuts by year end, we would not be surprised to see that action reversed in the weeks ahead as the Fed maintains its higher for longer message and as the banking sector stabilizes. If this turns out to be the case, look for continued pressure in equities and growth stocks to give back the recent gains.
Week in Review:
The fallout from two bank failures, SVB Financial and Signature Bank, continued at the start of the week last Monday, even after the FDIC came in and said SVB depositors would have full access to their funds in the morning, even those that were uninsured, with regulators citing systemic risk. Bank stocks saw additional declines, hitting regional banks hard, with the KBW bank index having its worse day since March 2020 (the onset of the pandemic). The action by the FDIC, Fed, and Treasury calmed some contagion fears with stocks recovering somewhat after steep opening declines. After being down 1.4% at the open, the S&P 500 finished the day down just 0.15%. Yields on Treasuries were extremely volatile and continued their declines, the 2-year finishing down about 60 bps to 3.96% while the 10-year finished down 13 bps to 3.55%.
Comeback Tuesday – stocks recovered substantially on Tuesday, led by bank stocks. The highly anticipated inflation report in the morning was in line with expectations – the consumer price index rose 0.5% in February and was 6.0% higher over the past 12 months, slowing from the prior month’s pace. Stocks were up as much as 2.1% before a report surfaced that a Russian fighter jet was ‘harassing’ a U.S. unmanned drone over the Black Sea, eventually striking the drone after getting too close, causing the U.S. to bring it down in international waters, increasing tensions with Russia. Treasury prices were weaker as yields recovered from Monday’s large drawdown while the S&P 500 rose 1.68%. Meanwhile, oil fell to its lowest level since December 2021 over global economic worries.
Overnight Tuesday Credit Suisse’s top investor, the Saudi National Bank, said it would not provide additional capital to the bank if needed, sparking additional fear in the European banking sector, which spread into U.S. trading. Data in the morning included producer inflation and retail sales which were both largely mixed, while manufacturing data showed activity continues to decline. Banking fears continue to be the worry, creating very high volatility in both the stock and bond markets. Treasury yields fell again while stocks moved another 0.70% lower.
It was Thursday evening that the Swiss central bank (Swiss National Bank) came in and offered a ~$50 billion lifeline to Credit Suisse to help it strengthen its liquidity position, calming markets again. The news calmed investor’s worries that the banking volatility would spread to Europe. Meanwhile, the European Central Bank still raised policy rates 50 basis points as expected, while saying there is no trade off between price stability and financial stability. Morning data included strong housing starts for February and jobless claims that fell back to January and February levels (very low). Markets got another sigh of relief after a group of banks got together to rescue First Republic Bank, which appeared to be the next bank to fail, by providing $30 billion in capital to help its liquidity position. The Treasury yield curve flattened as short term bond yields continue to fall, while stocks rose with the S&P 500 up 1.76%.
Stocks finished the week still on the roller coaster ride, down on Friday as banks remained under pressure after First Republic suspended its dividend and revealed the size of recent borrowing from the Fed, while Credit Suisse opposed a takeover bid by UBS. Consumer sentiment for March was lower than expected with inflation expectations falling, but it is noted the survey was taken prior to the banking issues. Yields dropped again while the S&P 500 fell 1.10% to close out the week.
There was a divergence between growth and value stocks last week, with growth outperforming on the hopes of lower interest rates soon with Treasury yields falling substantially. Commodities fell over global growth concerns after the banking issues surfaced, with oil having its worst week since April 2020, falling 13.0%. High quality bonds rallied as Treasury yields fell in an extremely volatile week – the Fed-sensitive 2-year note’s yield traded between 3.70% and 4.60%, ending at 3.83%, while the 10-year yield traded between 3.37% and 3.75%, finishing at 3.43%. The NASDAQ and growth stocks fared better than the broader market, with the major indices finishing as follows: NASDAQ 4.41%, S&P 500 1.43%, Dow -0.15%, Russell 2000 -2.64%.

Recent Economic Data

  • The consumer price index rose 0.4% in February, in line with expectations, after a 0.5% increase in January. Food prices were up another 0.4% in the month while energy was a detraction to the index, with energy prices down 0.6% in the month. Excluding the two volatile food and energy categories, the index was up 0.5%, slightly more than the 0.4% increase expected (and more than the 0.4% increase from January). Shelter was again on of the hottest categories (the substantial increase in home prices is now being reflected in the index) rising 0.8% in the month, while apparel increased 0.8%, transportation costs rose 1.1%, and recreation costs up 0.9%, but medical care costs fell 0.7% and used vehicle prices fell 2.8%. The medical category has seen consistent declines, this is due to consistent declines in health insurance costs, down another 4.1% in the month as the BLS changes the way it calculates insurance costs. It was interesting to see used car prices decline so much, as other data has told us there was a large rebound in used car prices. In the past 12 month overall prices are up 6.0%, meeting expectations and slowing from the 6.4% rate in January, while core prices (excludes food and energy) were up 5.5%, decelerating slightly from the 5.6% pace last month, driven by a 8.1% increase in shelter costs.
  • The producer price index declined 0.1% in February which was much lower than the 0.3% increase expected and slows from the stronger 0.7% increase in January. The decline was from a decrease in producer prices of goods and services and driven a lot by a 2.2% decline in food (where eggs were down 36%) and a 1.1% decline in transportation/warehousing. Excluding food and energy, core prices were unchanged in the month, lower than the 0.4% increase expected. Over the last 12 months the index is up 4.6%, much lower than the 5.4% increase expected and slowing from the 6.0% pace in January while the core index rose 4.4%, lower than the 5.2% expected and slowing from 5.4% in January. Also to note, the increase in January prices of 0.7% were revised lower to a 0.3% increase.
  • The NY Fed’s survey of consumer expectations shows the one-year ahead expectation on inflation fell 0.8% to 4.2%, while the longer-term three-year inflation expectations was unchanged at 2.7%. Feelings about the labor market improved even more, with the unemployment expectation decreasing while the probability of losing a job fell as well. Consumer’s outlook for spending growth fell slightly by 0.1% to 5.6%.
  • Prices paid on goods/services imported to the U.S. declined 0.1% in February, now declining seven of the past eight months. Compared to a year earlier, import prices have fallen for the first time this cycle, down 1.1% from last February, after seeing a record high 12-month increase of 13.0% last March. The decline was driven again by a drop in the price of fuel imports, down 4.9% in the month. Import prices excluding fuel rose 0.4%. Export prices rose 0.2% in February, the second consecutive increase after six months of decreases. Despite the increases, export prices have fallen over the past 12 months as well, the first time this cycle, down 0.8% over that period, after a record 18.6% 12-month increase in May and June last year.
  • Consumer’s feeling about the economy fell for the first time in four months, according to the latest consumer sentiment survey. The survey, compiled by the University of Michigan, showed sentiment worsened due to economic uncertainty and stubbornly high inflation. It is important to note the survey was done prior to any of the banking issues. The headline survey index fell from 67 to 63.4, with current conditions at 66.4, down from 70.7, and expectations over the next six months down to 61.5 from 64.7. Consumers see inflation falling to a 3.8% rate over the next 12 months, down from 4.1% in February.
  • The manufacturing sector showed further deterioration in the beginning of March, according to two regional surveys. The Empire State Manufacturing survey index was -24.6 for the March survey, another substantial drop from -7.7 last month, with about half the respondents noted worsening conditions. New orders “dropped significantly,” shipments fell, and delivery times shortened again suggesting supply availability improved. Employment and hours worked declined while selling price increases slowed.
  • The Philly Fed manufacturing survey index was -23.2, matching February’s weakness and the 7th consecutive negative read, as all indicators for current activity were negative. The majority of respondents reported no change in activity while 35% reported declining activity. New orders and shipments declined to the lowest levels since May 2020, employment declined, and prices continued to rise overall, but the index for prices paid and prices received both declined again (good, but still elevated).
  • Homebuilder sentiment increased the by the largest amount in over a decade, according to the housing market index. The index rose 7 points to 42, still a historically low level (anything below 50 is considered negative) but the highest reading since September after bottoming at 31 in December. All three components of the index, current sales, sales expectations, and buyer traffic, all increased at least 6 points in the month.
  • The number of housing starts in February surprised significantly to the upside, rising 9.8% from January levels to a seasonally adjusted annualized rate of 1.450 million housing starts, but still 18.4% below the levels from 12 months ago. Starts on multi-family homes drove about all the increase rising 24% in the month, while starts on single family homes rose 1.1%. Over the past year single family starts are down 32% while multi-family starts are up 9.9% as builders are more reluctant to invest in single family homes. The number of permits filed to build a new home significantly beat to the upside as well, rising 13.8% in the month to an annualized rate of 1.524 million, but still 18% below the level 12 months ago.
  • Monthly retail sales for February declined 0.4%, this was near expectations as a decline was expected after a very strong 3.0% increase in January (which was actually revised higher to a 3.2% increase). There were declines in eight of the 13 major categories, with the largest declines in home furnishing stores (-2.5%), restaurants and bars (-2.2%), and vehicle sales and miscellaneous stores (both -1.8%), with increases in e-commerce (+1.6%) and health/personal care (+0.9%). Excluding the volatile categories of gas and vehicle sales, retail sales were much better than expected, with no change compared to January, versus a 0.9% decline expected.
  • The number of jobless claims for the week ended March 11 fell 20,000 to 192,000 back to the levels they have been at for all of 2023. The four-week average was relatively unchanged at 196,500. Continuing claims declined 29k to 1.684 million, with the four-week average down slightly to 1.676 million.
  • Industrial production in February was unchanged versus the expectations of a 0.2% increase. There was a 0.1% increase in manufacturing, 0.5% increase in utilities, but offset by a 0.6% decline in mining. Utilization, which measures potential output, was 78.0%, lower than 78.4% expected, and lowest utilization level since mid-2021.

Company News

  • Facebook parent Meta said it will cut its workforce by another 10,000 people and withdraw 5,000 open roles that it has not filled, while canceling some lower priority projects. It reduced its total expense forecast for 2023 further, now expecting total expenses in the range of $86-$92 billion (down from $89-$95 billion).
  • California reversed a lower-court decision and upheld proposition 22 which would allow companies like Uber and Lyft to continue to treat their drivers as independent contractors rather than employees. The two stocks were higher as a result.
  • The parent company of SurveyMonkey, Momentive, said it agreed to be taken private by private equity firm Symphony Technology Group for $9.46 per share, valuing the company at $1.5 billion, or a 22% premium to the closing price before the announcement. Prior to the announcement, reports surfaced that the company was considering a possible sale after receiving interest.
  • The Committee on Foreign Investment in the U.S. (CFIUS) is giving the owners of TikTok an ultimatum – the WSJ is reporting CFIUS is demanding TikTok parent company ByteDance must spin off its shares or sell the business or else face a possible complete ban in the U.S. TikTok executives have said 60% of ByteDance shares are owned by global investors, 20% by employees, and 20% by its founders; who have the majority of voting rights. Separately, the UK said it will ban TikTok from government devices, following a recent move by the U.S.
  • The NY Post reported there are talks ongoing between TikTok and potential buyers. Then, The Information reported, citing lawyers and investors in China, that the Chinese government is unlikely to go along with an attempt to force a sale of Chinese investors’ stake in the company to non-Chinese holders. Also, the reports of potential forcing a sale is now having an impact on its ad business with advertisers holding back on increasing spending while the matter develops, the report notes.
  • A group of banks (JPMorgan, Bank of America, PNC, Citi, Wells Fargo, Goldman Sachs, and several others) provided $30 billion in capital to First Republic Bank to help support its liquidity position. The bank was facing significant outflows, as a significant amount of its deposits were uninsured, had its credit rating cut to junk, and was reported to be exploring an outright sale.

Other News

  • One of the top three credit rating agencies, Moody’s, said last week it cut its view on the entire banking system to negative from stable, citing a “rapidly deteriorating operating environment” following the deposit runs over the past several days.
  • Reports surfaced last Tuesday that a Russian fighter jet was ‘harassing’ a U.S. unmanned drone over the Black Sea by dumping fuel on the drone and flying in front of it in a reckless manner. Another Russian jet eventually struck the propeller of the drone after getting too close, forcing the U.S. to bring it down in international waters. The U.S. says the drone was doing routine operations over international airspace. Russia already defended itself, saying the drone flew in the area of Crimea and was downed after it went uncontrolled after sharp maneuvering.
  • Markets saw another spike in volatility and new concerns from the banking sector after one of the largest investors in the Swiss bank Credit Suisse, the Saudi National Bank, said in an interview after being asked if it would provide further support to the bank if needed, “absolutely not, for many reasons outside the simplest reason which is regulatory and statutory.” This added to the banking fears in the U.S. It was a day prior that Credit Suisse released its annual report in which it said it identified “material weakness” in its reporting procedures. It was the next day Credit Suisse asked the Swiss central bank (Swiss National Bank) and regulators to show public support. SNB and regulators decided to grant that wish, providing a ~$50 billion lifeline to help Credit Suisse strengthen its liquidity position and calming market fears once again.
  • It was an important policy meeting by the European Central Bank last week, which will have the markets speculating on what the Federal Reserve will do at this week’s meeting. The European Central Bank raised policy rates 50 basis points, despite the banking turmoil, but as was expected. ECB President Christine Lagarde said regarding weighing the risk between raising rates to fight inflation and keeping stability in the financial system: “I believe that there is no trade off between price stability and financial stability and I think that if anything with this decision we are demonstrating this, we are addressing the price stability issue by raising interest rates by 50” basis points. The big question for the Fed at this week’s meeting will be is the banking situation worse in the U.S. where there IS a tradeoff between inflation and stability in the banking system.
  • Could it be an end to quantitative tightening and the start to quantitative easing? Much of the work done in reducing the Fed’s balance sheet since the beginning of 2022 was reversed in the matter of a several days last week. After declining from about $9 trillion (yes, trillion with a T) to around $8.3 trillion since March 2022, the size of the Fed’s balance sheet increased $297 billion over the past 7 days ending March 15 to $8.64 billion. This is due to financial institutions borrowing $153 billion from the Fed’s discount window, a small amount from the (newly created after Silicon Valley Bank’s collapse) Bank Term Funding Program ($12 billion), and more in the form of bridge loans which was used by failed banks.

Did You Know…?

Higher Interest Income

The effect of higher interest rates on different businesses is starting to be felt throughout the economy. This is the driving factor behind the banking issues we have seen over the past two weeks, from banks mis-managing interest rate risk (Silicon Valley Bank) to bank clients withdrawing deposits to find higher yields. But for some, especially some of the largest corporations in the world, higher rates have been a way for them to build their already bloated cash positions. Per Barron’s, Apple has the largest cash position of any U.S. company at $165 billion as of December 31. Higher interest rates have helped it grow its interest and dividend income to $868 million for the fourth quarter alone, up 33% from the same period a year earlier when its cash position was 23% higher at $203 billion. Apple invests its cash in short-term and longer-term debt instruments, while Warren Buffet’s Berkshire Hathaway plays it safer and invests its cash in short-term Treasury bills which mature less than a year. With its Treasury portfolio rolling over quickly, Berkshire’s interest income increased over six-fold to $896 million in the latest quarter, and Barron’s estimates it could generate over $5 billion this year in interest income, given the Treasury bills 5%+ interest rates.

WFG News

Updates on 2022 Tax Documents

Please note tax documents will not start mailing until January 31. Most retirement accounts will see 1099-R and form 5498 mailed on January 31. Retail accounts will see 1099 and related documents mailed by February 15. Certain accounts with more complex securities may have 1099’s mailed as late as March 15. Please see this email for more details. If there are any questions on tax documents, please reach out to us at 330-650-2700.

Regarding Market Conditions

We understand the volatility in the markets and headlines you see regarding the banking sector may be concerning. We expect further weakness in the markets in the weeks and months ahead as investors digest the collapse of SVB and Signature Bank and the lingering effects on the economy/markets, but do not expect this to lead to a financial crisis or a similar event. However, an event like this will lead to further uncertainty and will have substantial effect on sentiment. We are working diligently to analyze all client portfolios and assessing ways to reduce risks and/or find opportunities. As always and particularly in instances such as this, it is important to not lose sight of your longer-term financial objectives.
If you have any questions or concerns in the meantime, please do not hesitate to reach out.

The Week Ahead

The main event this week will be the second Federal Open Market Committee (FOMC) meeting of the year. The meeting will be held Tuesday and Wednesday with a policy announcement at 2:00 on Wednesday and a press conference by Chairman Jerome Powell following. Market expectation on how much, or if, it will raise rates have jumped back and forth since the banking crisis started, but current consensus sees a smaller 25 basis point increase in policy rates. The meeting will include the Fed’s summary of economic projections, which allows us to see Fed officials projections on interest rates, growth, inflation, and employment. Other central bank meetings include the Bank of England and its policy decision on Thursday. On the economic calendar we will see existing home sales on Tuesday, New home sales and jobless claims on Thursday, and durable goods orders on Friday. Another light week for earnings; Foot Locker, Nike, KB Homes, Chewy, Darden Restaurants, and General Mills will all report quarterly results this week. Chipmakers will be presenting at one of the largest conferences of the year for chipmakers at the GTC Conference. In global geopolitics, Chinese President Xi will be making a trip to Russia to meet with Putin this week, in what is viewed as a move to tighten their relationship.