💵 Entering The Next Market Phase

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Remember the US banking crisis of 2023? It's over. Remember when that Systemically Important Swiss Bank was merged with that other Systemically Important Swiss Bank? That's over too.

So... what's next?

I checked my crystal ball. It doesn't know. Checked my Magic 8 ball. That didn't help either...

So, let's take a look at what's happening now...

We've navigated the banking crisis without too much pain. Some regional bank business models have taken a hit from the rapid rate rise (and the free advertising money market funds and larger banks got from the coverage).

But Silicon Valley Bank was unique in many ways. They took their asset/liability mismatch to extremes and their incestuous depositor base of highly-connected & ultra high net worth customers (a massive 94% of SVB deposits were above the FDIC limit of $250,000) made them especially vulnerable to a bank run.

Bank earning calls have been no disaster so far. Pretty much what you'd expect in a slowing economy. More regionals will report this week, but the banking emergency looks to be a fading theme... 👇

It might not be over, but it's over for now... The 3 month 10 year spread remains deeply inverted, which isn't helpful for lending, and portfolio mark to market losses remain a potential concern/risk...

Economically, there are more mixed signals than anything else. Especially for wages/incomes.

Bank of America's Consumer Checkpoint report highlighted a downturn in wage growth, especially for the high income group 👇

BofA says the higher-income duress "could be due in part to hiring freezes orjob cuts in industries such as tech and financial services, which are putting downward pressure on wages in these sectors".

At the lower end of the income scale, the SNAP (Supplemental Nutrition Assistance Program) is returning to normal...

It's not a cliff edge, more of a 'right-sizing' as the generous pandemic era programs end... 👇

Those benefits won't disappear entirely, but the drop is likely to impact spending capacity at the lower income levels.

To top it off, BofA data points to lower-income households receiving smaller tax refunds, although some of the difference is exaggerated by the end of the enhanced Child Tax credits which juiced refund sizes in 2022.

It's a messy picture, best summed up as "things aren't as good as they were, but those times were exceptional..."

Transitioning from exceptional to terrible/slow (rate hikes are intended to slow the economy & wage growth) is a process.

It takes time, and it doesn't look like we're there yet...

Contrary to the BofA data, the Atlanta Fed wage growth tracker still has wages well above trend.

And, in a wonderful twist of fate, annual inflation is falling rapidly. As the months of huge energy driven inflation disappear from the comparison, we're likely looking at US inflation with a 3 handle by June.

Lower inflation is a double-edged sword. On one side, real wage growth turns positive. Inflation eating away less at incomes leaves purchasing power intact and/or rising... 👇

On the other side, this inflation drop would put short term rates firmly in positive/restrictive territory. Longer term rates, not so much. This missing term premium has been supportive of equities. If you want to put money to work over a longer horizon, you still only get 3.5% in US 10 year bonds.

Perhaps we're at a tipping point here too.

Presuming the Fed delivers another 25bps hike in May, the seemingly magical 5% handle will be achieved. But only at the front end.

Inflation is expected to stay below 4% for the rest of the year with economic growth slowing...

John Authers' note yesterday contained these two snippets 👇

Arguably, the second statement describes where we are now, while the first statement is more likely where we're eventually heading...

But when?!

The million dollar question. It's not hard to envisage company earnings generally staying resilient (or not as bad as feared) as input costs fall and the economy ticks along, buoyed by renewed inflation-adjusted spending power on the consumer side.

But that won't last indefinitely...

So what can keep the stock market underpinned, or even pushing higher from here?

It's the liquidity, stupid

Or at least... It was.

I keep wondering... Have we seen the latest liquidity peak?

An upcoming theme is liquidity withdrawal. Once the debt ceiling situation is resolved, the Treasury will need to refill the general account, sucking liquidity out of the financial system and into their coffers as they do.

Ironically, the debt ceiling resolution is a potentially bearish catalyst.

Problem is... The debt ceiling resolution could be rapid (wishful thinking?) or drag on for months yet.

Yellen says the Treasury can hold out until June, some analysts think they could last longer.

Until the resolution, the TGA can't be refunded.

At some point in the next 12 months, the US economy will obviously collapse too, (otherwise The Economist covers will have lost their mojo as a contrarian indicator...) 👇

From a valuation perspective, it's hard to shake the feeling that there's little room for error with stocks up here.

Immaculate disinflation seems unlikely. If the economy picks up, other things happen too. Like fuel prices rising, which can trigger another round of inflation (nowhere near the first one, but maybe enough to stop the Fed from cutting this year)

RBOB = Gasoline Futures

So, what's the next market phase?

Uncertainty. While it would be no surprise to see the S&P 500 seek out some liquidity in the 4200 zone, spending much time above there seems unthinkable, but then sentiment and positioning (see below) don't exactly scream that markets are exceptionally bullish or ignoring risks either...

Likewise, it makes little sense (to me) to bet on positive catalysts propelling the index significantly higher. Employment numbers have started to turn lower, and betting on the Fed pivoting at 'just the right time' while we're this side of 4k just isn't appealing.

Loads of talk about hedge fund positioning setting things up for a squeeze.

Hedge funds are 'very short' (but nobody knows if those positions are hedges or directional bets), while CTA's are apparently flipping long the S&P 500, with some speculating that they'll chase higher on a break of 4200...

Even as tech is 'most overcrowded' per BofA's fund manager survey, and 'everyone's' underweight equities vs bonds...👇

Messy.

The banking crisis should be another factor to crimp lending over time, creating a drag on the economy and eventually the stock market, but it's hard to strongly advocate for shorts with this kind of sentiment and positioning...

Fun times ahead. In my humble and unbiased opinion, if you're going to FOMO long into anything today, it should be this 😉 👇