The Week Behind

Friday’s early-session rally sparked by Payrolls was overwhelmed by Silicon Valley Bank’s (SVB) collapse. Contagion concerns catalyzed a vicious, broad market plunge. For the week, the major indices – NASDAQ, DOW, S&P 500 – finished the week ~4.5% lower. 

Highlights 

• China’s 2023 GDP projections came in soft, causing a decline across commodities.
• Powell’s testimony at Congress revealed revisions to January data have altered the Fed’s view on inflation. As a result, a 50 bps hike is under consideration, and investors should be prepared for next meeting’s projections to feature a higher target rate.
• Initial jobless claims printed the highest level of 2023 at 211k, which indicates slack is being created in the labor market.
• Due to the stress of financial tightening and inadequate risk-management, regulators seized Silicon Valley Bank (SVB), the 16th largest bank in the U.S.

Recapping Payrolls

Heading into Payrolls, the market’s biggest question was how it would affect the Fed’s next move and the target rate. Although the collapse of SVB drew attention away from this discussion, let’s try to answer that question as if SVB were not a story.

I like to analyze Payrolls by reviewing job creation, unemployment, and average hourly earnings.

• February job creation was 311k, which was above estimates of 200-225k, but lower than January’s revised figure of 504k (originally 517k). 
• Unemployment slightly ticked up from 3.4% to 3.6%.    
• Average hourly earnings rose 0.2% MoM, lower than the estimated range of 0.3-0.4% and January’s 0.3% increase. YoY, earnings rose 4.6%, which is below the 4.7% consensus but above January’s 4.4%.  

The Fed has indicated they are comfortable with strong job creation as long as it is not accompanied by strong wage inflation. For a third consecutive month, the U.S. economy experienced robust job growth with moderating wage inflation. Additionally, the slight uptick in unemployment and labor force participation suggests the supply of labor is expanding, which can keep downward pressure on the cost of labor (wage inflation). 

Based on this data, it is my opinion this report supports a 25 bps hike at the next meeting. Furthermore, it does not immediately validate the need for a target rate above 6%. 

The Week Ahead

In the aftermath of SVB, the market is on contagion watch. Investors are hoping for evidence that confirms analysts’ notes from Friday characterizing SVB as an isolated event. At any moment, developments surrounding SVB have the power to boost or depress the market.

Understanding that SVB has the influence to turn markets on a whim, we turn our focus to February CPI, which releases before Tuesday’s open. The consensus for February CPI is 6% on headline and 5.5% on core. The prior month’s numbers were 6.4% and 5.6%, respectively. Core will be the metric to watch. In my opinion, incremental data does not offer a clear prediction; however, I think the market will view CPI with a bullish or dovish bias in the aftermath of SVB. 

While SVB’s management played a large role in their own demise, an argument could be made that the failure would not have occurred if not for Fed policy. As a result, SVB provides a compelling reason for the Fed to proceed with caution. Consequently, I do not think a hot CPI will sway the market consensus on 25 bps. Benign Payrolls provides additional cover 25. Furthermore, a benign number could tempt markets to price-in a pause in March, which would generate a powerful, albeit short-term, tailwind for stocks. 

Otherwise, on Wednesday we get PPI and Retail Sales. On Thursday, alongside weekly jobless data, important housing indicators are released: housing starts and building permits. Housing starts will garner additional attention because last month’s number was the lowest since coming out of the pandemic. We need more houses to be built in order to bring down housing inflation. Friday, a slew of economic reports – industrial production, capacity utilization, and leading economic indicators – are released. However, similar to my thoughts on CPI, even if these numbers suggest the economy is too strong for disinflation, bulls will argue that these numbers do not reflect a post-SVB world. 

How To Approach Silicon Valley Bank

Later today, I will release a new series of articles called “Response Function”. The first covers Silicon Valley Bank. It does a good job explaining how the event happened, why it matters, and how involved parties will respond. It would have been too long to put in the brief, but I will take a moment to share how I am positioning.

I believe SVB will be an idiosyncratic event with ripple effects contained within technology. I do not view SVB as a systemic risk to markets. However, due to our limited knowledge of the situation, it is too early to aggressively add to equities on this decline. It is impossible to understate the magnitude of this event: 

For the first time since the 2008 Great Financial Crisis, a bank failed. Not just any bank. Not just a small bank. The 16th largest bank in the country. This kind of story brings out the “sell now and ask questions later” mentality. 

In other words, now is the time to get out your wishlist and circle the names that are far removed from the economic impact of SVB. I am talking about companies in healthcare, energy, defense, and staples. Once the fear stabilizes, as measured by the VIX, I will be nibbling at these companies because they are the furthest from ground zero. Financials and technology find themselves at the epicenter. Until there is more clarity on the situation – which could take days, weeks, or months – the risk-reward is too skewed to the downside because these companies are the most liable to be sold off in the crossfire.