The Week Behind

In spite of a sloppy start to Friday’s session courtesy of bankruptcy fears surrounding Deutsche Bank, U.S. markets were able to recover after European markets closed, alleviating the primary source of selling pressure. All the major indices tallied off a week in the green. The DOW added 1.18%; the S&P gained 1.39%; and the NASDAQ advanced 1.66%.

Highlights 

• The latest existing home sales figure added to the collection data suggesting that the supply of housing is expanding. The figure beat estimates and broke a persistent downtrend. Moreover, data does not yet reflect the anticipated impact of lower rates, which should make mortgages more accessible, further incentivizing homebuilding. With a fresh catalyst, this expansion should continue, which should lower housing inflation.  
• The Fed hiked 25 bps but indicated a pause could come at the next meeting.
• Deutsche Bank became the new pain point in the banking scare. Overnight, Thursday into Friday, credit default swaps (CDS) for the bank spiked. Most simply, a volatile rise in a credit default swap implies elevated risk of default (bankruptcy). Given banking tensions, this heightened contagion concerns, spooking markets.     

Deutsche Bank versus Credit Suisse

The two are not alike. Deutsche Bank (DB) is a profitable enterprise. Credit Suisse is not. There are some theories that the action in DB’s credit default swaps, which was the initial source of concern, was spurred by tweets from prominent figures in finance. In my opinion, the hype surrounding Deutsche Bank seems greater than the reality; whereas, in the case of Credit Suisse, the hype was the reality. 

KRE: The Only Chart That Matters

I monitor a number of screens to contextualize market moves, and, in light of regional banking concerns, I believe the heartbeat of the market now resides with the KRE, the SPDR Regional Bank ETF.

• If KRE is up, sentiment is bullish and markets can rally.
• If KRE is flat, sentiment is neutral and markets are more likely to advance than decline, as I think we are in a “no news is good news” environment with respect to the banks.
• If KRE is down, sentiment is bearish and markets will sell off.

The KRE is the stock market’s proxy for sentiment on the banking situation. Until the banking situation is resolved, which I expect will be marked by a sustained upward move in the KRE, this ETF will be a dominant force in the market, just like treasury yields and the US dollar have been over the last 12-15 months. 

The Week Ahead

This week features a healthy mix of micro and macro.

With respect to the micro, my eyes are set on earnings from McCormick (MKC), Micron (MU), and Paychex (PAYX). 

MKC’s global reach makes it an important source of information on supply chain trends. Additionally, in a recession, the company’s name-brand seasoning would be adversely affected by trade-down to lower-cost private label substitutes. Investors will use what the report reveals on that dynamic to gauge recession probabilities. 

MU’s report is crucial as semiconductors are a leading indicator for the market as a whole. A bullish report would benefit the semiconductor cohort and, by extension, the broader market, while a negative report would have the opposite effect.

PAYX, which provides payroll services to small-and-medium sized businesses in the U.S., is of particular interest due to the recent bank failures’ potential impact on these businesses that are responsible for a majority of the country’s job creation. PAYX’s access to relevant data could provide insight into any hiring freezes or layoffs, which would cool wage inflation.

MKC and MU report on Tuesday: MKC before trade; MU after. PAYX will report before trade on Wednesday.

On the macro front, PCE for February caps off the week. However, as it only includes data from February, it does not reflect the impact of the recent bank scare on inflation. This makes it difficult to anticipate how the market will react. The consensus for core is 4.7%, which matches January’s reading. I believe the best and most likely scenario is an in-line or slightly cooler PCE. However, if there is a sudden collapse in PCE, it could rekindle recession fears. Such an outcome would imply that the Fed’s tightening policies had meaningfully damaged the U.S. economy before the data had a chance to reflect the effects of a significant bank failure and an additional 25 bps hike. While I consider this to be an unlikely scenario, it’s important to keep it in mind.

Tightening Cycle: End-Game 

Regardless of how you feel on the Fed’s decision to hike despite the recent bank failure, several indicators appear to have found consensus on a related matter. Through their Fed Funds proxies, the bond market, forex market, stock market, and the Fed are all signaling the same thing at the same time: the current tightening cycle is coming to an end. 

Performance from Silicon Valley Bank’s Failure (3/10/23) to Friday’s (3/24/23) close:

• The bond market’s proxy, the US2Y, experienced a drastic decline, greater than 100 bps. 
• The forex market’s proxy, the USD, in an oversized move, dropped 2%.
• The stock market’s proxy, the NASDAQ, outperformed peers, rallying 6.1% compared to the DOW’s 1.3% and S&P 500’s 3%.
• The Fed’s proxy, the dot plots, remained unchanged at ~5.1%, despite constant messaging the dot plots would revise rates higher.  

These oversized moves in the bond and forex markets coincided with outperformance in the NASDAQ, which would be the most attractive stock index at the end of a tightening cycle, coupled with the Fed’s dot plots messaging a pause is near all points towards the same conclusion: an end to interest rates hikes is inevitable.