27 Mar Capital 19 Catch-Up
Weekly Index Movement
| S&P500 | +1.4% |
| Nasdaq | +2.0% |
| Aussie All Ords | -0.7% |
After the excitement of the prior week, last week was somewhat of a letdown, but there were some important events that we need to cover as the investment landscape is changing.
If anyone thinks we are in the middle of a banking crisis they just need to look at the positive performance of stocks to dispel that illusion.
The biggest event of the week was Fed Chair Powell’s press conference, which did not go the way I expected it to.
Powell increased rates by 25bps as expected, but the tone of his words was very different from the past.
What he says at these press events is often more important than the decision as it gives you a glimpse into the future.
Two points he made changes the entire landscape.
He said they had considered a pause and also that the banks tightening credit in response to the bank failures we saw has a similar impact to the Fed raising rates.
Taken together these two points clearly tell the market the Fed is near the end of the interest rate cycle.
Indeed, according to the CME FedWatch tool, the market puts high odds (82%) on no hike at the next meeting on May 3rd. The odds interest rates also remain unchanged at the following meeting of June 14th is 63%.
If the Fed does change rates on June 14th, the market gives greater odds of a 25bp cut (25%) than a 25bps rise (12%).
US interest rates are now at 4.75 – 5.00 percent.
By the December meeting, the market sees the highest odds (37%) of the Fed Funds rate being 3.75 – 4.00 percent. That is an entire 1% lower than where they are today and implies 4 cuts from here before the end of the year.
Which is why the Nasdaq was the best performing index last week.
But I just do not buy into these rate cuts.
Firstly because Powell said
“just don’t see rate cuts this year”
and secondly because core PCE inflation (Fed’s preferred measure) is running at +4.7%.
Let’s say I am wrong and the market is right. What could cause 4 cuts this year? Just about the only reason I can think is recession. I can’t find any other justification for thinking Powell will cut 4 times by the end of the year.
That places a question mark over the gains we have seen in Tech this year.
The other news item this week came from European banks. We covered UBS buying Credit Suisse last week.
UBS is a much more conservative bank that has just picked up billions of assets for a fraction of the value. There is some small restructuring risk but overall this is a large value add move for UBS and tempts me to buy the bank. But upside is probably limited to 20-25% so I think I will pass.
The market thinks this deal has made UBS more risky
I don’t agree with this risk. UBS just bought $65bn of equity value for $3bn. Plus the Swiss National Bank is basically going to have to backstop UBS now. The SNB has agreed to cover $9bn of potential bad debts for UBS.
No doubt you would have seen the news over the weekend about Deutsche Bank experiencing a similar thing on its Credit Default Swaps (CDS)
A CDS is a way of insuring against risk of loss due to credit default by the bank. It has spiked higher this year, but is no higher than 2016, or 2018 or 2020 – and nothing happened then. This is just the nature of CDS. Prices are volatile and can spike quickly but it does not mean there are serious risks of default.
Last week also saw the first moves in crypto becoming legitimised. Coinbase (a major crypto wallet and exchange) was issued with a “Wells Notice”. The final warning before a legal battle kicks off.
The bone of contention here is whether crypto’s technically a security or nothing more than a currency of exchange: after all, it’s only securities that feel the intense glare of full SEC regulation. The authority’s doggedly insisting that Coinbase lets crypto be used as a kind of investment vehicle, while the firm’s saying crypto’s a whole lot closer to a commodity. Looks like one for the lawyers to battle out…Bad for crypto as regulation is costly and crypto enthusiasts like anonymity. But also legitimises it as a viable investment asset.
Personally, I think it is time crypto got regulated. Look at what happened at FTX and SIVB. Regulation is expensive, but it protects investors. If they do ever regulate crypto I might even have to change my tune on the ponzi scheme.
Going back to the collapse of SIVB for a second. How this happened is important to understand. SIVB received large deposits from 2018 onwards. It would invest these deposits in bonds to earn a return. But short term bonds were paying almost zero after the pandemic in 2020.
SIVB managed the attain the highest margin in the industry at this time by investing in long term bonds which still paid some kind of interest.
The problem occurs between the short term nature of deposits and the long term nature of their investments. If they had done like other banks and matched short term deposits with short term investments – they would not have had a problem. But then they would not have made such a big profit and the directors could not pay themselves big salaries.
This is what regulation does. It stops companies taking risky moves for profit. It is why the large banks are fine and the only worry is around the small banks. But even they should be fine if they are responsibly run.
Last week we saw $120bn of deposits pulled from small banks. $67bn of this found its way to the large banks. Even though the absolute value of these numbers sounds high, it isn’t a lot and given where we are with small bank sentiment, I think this number is surprisingly low.
Now the market has decided it knows where the Fed is going, the focus is going to come back to earnings which will begin in less than a month.
I feel it is still too early to jump back into tech. I’m worried about the expectations of interest rate cuts and also the fact tech still trades on a PE that demands large ongoing increases in profits.
At the same time I am not worried about recession, something the FedWatch tool seems convinced of.
This graph is the spread between investment grade and high yield bonds over Treasuries. As fears of recession grow you can see the spreads increase. Take a look at 2000 and 2007. These markets do a good job of early warning calls of a recession.
As you can see, there are no signs this market fears recession., which would be supportive of equity prices
Summary – we have a mixed bag of indicators this week. Best to stay on the side and let it work out where focus should be.
Lastly, this is how I envision Credit Suisse traders on their first day at UBS
Warning
Stock values can go down as well as up. It is possible to lose 100% of your investment in a stock. Any advice given by Capital 19 is general advice only and does not take your personal circumstances into account and might not be suitable for you.