Published March 31, 2023
The stock market appears to have shrugged off the recent bank crisis and is ready to press upward. Does this mean the bear market is over? We have a couple of competing views below. First, Delta Research provides an overview of the market and reasons for the recent thrust higher. Second, Barron’s offers a warning. Third, we have a chart that supports both cases, depending on your perspective.
Here’s Delta’s overview:
“When walking my 7.6 lb. toy poodle, she pulls fearlessly forward on the leash. There is a good probability the dog has no idea where she is eventually headed or what risks she faces on the journey. None of these information gaps cause her to hesitate.
The stock market seems to be pulling fearlessly forward this week. In the face of rising interest rates, potential earnings and economic recessions and a regional bank crisis, a strong stock market seems counterintuitive.
The collapse of Silicon Valley Bank and the concern for the financial health of the regional bank sector might be a root cause for recent market strength. Weakness in the bank sector is expected to tightening availability of bank credit (i.e., it will be harder to get a loan from a bank). Credit tightening is disinflationary as it slows economic growth.
Fed Chairman Powell acknowledged that the impact of bank credit tightening is “rule-of-thumb guesswork. But we think it’s potentially quite real” and “it could easily have a significant macroeconomic effect.” As the Fed themselves have said, this kind of credit restraint – much like a fiscal tightening – should be viewed as a substitute for rate hikes. Many institutional credit analysts believe the Fed will not raise interest further this year as a result of the regional bank crisis.
The shift from monetary tightening to credit tightening means sectors with high exposure to regional banks will be negatively impacted much more than sectors with little connection with regional banks. Large businesses with access to big banks, strong balance sheets, high free cash flow and public markets should see a relatively small growth drag in a tighter credit/lower rate environment. These large companies dominate the large-cap US equity indices making equity indexes resilient.
Below is a chart showing index weights of many of the leading large-cap technology stocks. They represent about a quarter of the S&P 500 and over half of the NASDAQ 100.
The next chart shows the dispersion in U.S. sector performance since the bank crisis began on March 8, 2023 through March 27. The most impacted sector from the regional bank crisis are regional banks. Financials is the worst performing sector on the chart. Last week in Delta Insights, we talked about the tremendous amount of real estate financing coming due in the next twelve months from regional banks. Real-estate is the second worst performing sector. The decline in energy, materials and industrials may be attributed to an increased risk of recession. Consumer discretionary is holding up relatively well as consumer confidence, employment and retail sales reports are coming in ahead of expectations currently.
Utilities, healthcare and consumer staples are sectors with little exposure to regional banks, are defensive and include many large market capitalization companies. The strength in these sectors reinforces the strength in information technology and communications and does much to explain overall index strength.
It has been about three weeks since the collapse of Silicon Valley Bank and the decline in the regional bank sector. What is now evident is than since March 8, the U.S. capital markets have essentially frozen. The chart below shows fund issuance from Investment Grade (IG) and High Yield (HY) debt and Initial Public Offering (IPO) activity. In another case of the strong-get-stronger during tough times, merger and acquisition activity has accelerated.
This is not the first time we have seen high-margin technology stocks perform well when the overall economy is under stress. We saw a similar disparity of risk dispersion during the Covid shut-down. The decline in the 10-year interest rate was another important commonality between today and 2020.
The ripple effects from the regional bank crisis are likely to continue for the foreseeable future. Once again, large cap technology appears to be a safe-haven in the storm. For market index buyers, this is good news.
Barron’s warns us not to get overly excited:
Here’s the chart view, showing the ratio of the equal-weighted S&P 500 to the cap-weighted version. The cap-weighted version is driven by a much smaller set of companies as Delta’s article above notes. When the line is falling, the megacap tech stocks are doing the heavy lifting for the index. When the line is trending upward, the broad market and its wide swath of stocks are doing the work, usually seen as a healthier market force. Recently, the megacap tech stocks (FANGMA) have been pushing the market higher. The ratio has plunged to an oversold condition (noted by the red circle on the chart bottom). Often, this oversold condition has been short-lived, though it certainly does not mean the broad market moves higher. In 2020, the megacap tech stocks took flight with the broad market not fully following (in terms of equal-weight outperforming) until nine months later. We want to see this ratio start to move upward for the rally to be more sustainable.
Market Update
A weekend free of any new bank crisis concerns left stocks free to migrate higher Monday with a +0.2% advance as investors entered the last week of a turbulent first quarter of the year. That lift was given back Tuesday when interest rates ticked higher perhaps responding in part to a surge in oil prices. Oil prices have recovered losses sustained a couple of weeks ago as recessionary and systemic global banking fears have abated. Stocks took another step higher Wednesday when semiconductor firm, Micron Tech, issued a positive outlook on the industry. The Nasdaq popped almost +2% while another semiconductor maker, Intel, zipped upward by almost +8%. International stocks added more fuel to the thrust upward Thursday with indexes globally moving +1% or more. A friendly inflation report kept stocks moving higher Friday. The report showed “core” inflation slowing to sub-5% and continuing a downward trend. Stocks broke out in volume with the S&P 500 crossing above 4100 and the Nasdaq hitting its highest levels since August of last year. Unlike earlier days pushed higher by technology stocks, Friday’s move found consumer discretionary stocks joining the move. The Consumer Discretionary ETF (XLY) gained +2.67% Friday.
Stocks found their stride this week with volatility easing back to where it was before the banking crisis. The S&P 500 added a solid +3.45% while the Nasdaq 100 (QQQ) rose +3.23%. Smallcap stocks joined in with a +3.85% weekly lift.
Warm wishes and until next week.