The Week Behind

Last week, the markets were extremely FED-focused as they struggled to find a posture through a difficult wave of FED-messaging. 

• Monday, indices were off to the races. 
• Tuesday, gains were given back as long-considered dove, Lael Brainard, Vice Chair of the FED, appeared to make a hawkish turn in a firm press release.
• Wednesday, losses continued into the FOMC minutes but did not accelerate on their release.
  • The minutes suggested 50 bps hikes and the potential for more aggressive reduction across the balance sheet, but not as aggressive as the Vice Chair’s statement hinted. 
• Thursday and Friday, the DOW was able to recover its losses to end the week slightly positive; the NASDAQ was unable to replicate the DOW’s recovery but did not meaningfully add to losses from Wednesday’s close. 

As per bonds, the bear market continued as rates rose across the curve. The 10-2 year spread uninverted. 

The Week Ahead

We are at the beginning of another earnings season. Banks will have a monopoly on the first week aside from Tuesday’s CPI report before the bell. Both bank earnings and CPI will be important moving forward. The former will provide insight on corporate and consumer strength via lending activity; the latter will provide data influencing the debate surrounding peak inflation, which concerns the FED. 

In short, if you are a bull, you want solid, but not explosive, bank prints. Explosive earnings may suggest that the economy is hotter than previously thought, pushing the FED to act more quickly. 

With respect to CPI, you want a cooler read to serve as hard evidence we’ve seen peak inflation, allowing the FED a little slack in tightening. If we see a hotter read, do not be surprised to hear President Bullard advocate for 75 bps. While the market has been rather resilient to hawkish messaging thus far, I am skeptical the markets would take that level of hawkishness in stride, especially in the wake of Brainard’s hawkish pivot. 

I think the Vice Chair’s comments convinced the market that the FED is willing to see a significantly greater drawdown than we have thus far to tackle inflation before taking action. In short, the “FED put” now exists at a much lower level than it did before her remarks on Tuesday.     

A Shift In Leadership

I want to draw some attention to last week’s juxtaposition between the NASDAQ and DOW. It could be a sign of an early shift in market leadership: growthier-tech to profitable-defensive. This is not an umbrella shift from growth to value, but a more distinct shift to companies that are currently profitable with growth detached from GDP. This would explain the positioning away from cyclical semis in the NASDAQ toward non-cyclical healthcare and staples in the DOW. 

I see a healthy bull market emerging in quality healthcare, staples, and energy/utilities. To get a visual, compare the major indices to UNH, MRK, COST, and WMT over the last month. It will be interesting to see how much positivity is priced in based on earnings reactions. I think these companies are approaching the point of being priced at, or even above, perfection. Consequently, even a perfect report will result in negative price action. 

To bring it full circle, I think the banks have a chance to join this bull rush with earnings as their catalyst. To paraphrase BofA analyst Ebrahim Poonawala, bank earnings are best linked to the spread between the 3-6 month and 5-year yields (2nd chart, green line); bank sentiment is best linked to the spread between the 2-10yr yield (3rd chat, blue line). The spread between the 3-6 month and 5-year is healthy and widening. Balance sheet reduction promises to fix the 10-and-2’s inversion at a more rapid pace than the market has already. In contrast to healthcare and staples, banks are far from being priced for perfection.