The Week Behind

Uncertainty in the labor market created by conflicting data and the Fed’s apparent disconnect from the regional bank situation catalyzed bearish price action throughout the week. However, with major known obstacles – First Republic, the FOMC Meeting, and April Payrolls – in the rearview, tension released on Friday, allowing for a relief rally that saved the indices from an outright horrible week. The Dow dropped approximately 1.25%, the S&P 500 fell 0.80%, and the NASDAQ ended about flat, up 0.07%.  

Highlights 

• U.S. job openings spooked the market with the worst print since the COVID-recovery. However, later in the week, both ADP and April Payrolls job creation figures came in well above forecasts. These conflicting signals make it difficult to gauge the strength of the economy and the risk of a recession.
• The Fed raised interest rates by 25 basis points and opened the door to a June pause. However, the Fed’s indifference to the regional bank situation created a sense that the Fed, FDIC, and Treasury have not made meaningful progress on a long-term solution.
• While Apple’s revenue and earnings beats were impressive, the 5% post-earnings gain is best attributed to their progress in India and Southeast Asia. By reducing their reliance on China and expanding into new markets, Tim Cook has convinced investors Apple has identified their next growth engine to propel the company forward as growth rates mature (plateau) in Chinese markets. The stock is now well-positioned to challenge its previous all-time high of ~$180.

A Fed Fumble

Since March, regional banks have been a paradise for short sellers as three banks have failed in nearly identical fashion. Large banks are waiting for distressed regionals to enter FDIC receivership before submitting bids, allowing short sellers to operate without worry of a takeover bid causing a short squeeze. Although the FDIC may have meaningfully resolved the bank run issue by fully protecting depositors in each failure, this solution does nothing to protect the short sellers’ target: the stock. 

Short sellers are indifferent to depositors. They profit as stock prices fall.  

While the Fed delivered on their 5.125% projection by raising rates 25 bps at the May FOMC Meeting, Powell’s commentary on the supervisory response suggested little meaningful progress had been made on a solution that spoils the opportunity for short sellers. Until such a solution is found, short sellers have the green light to double down and broaden out. However, if a creative solution is found, a short squeeze in the regional bank sector could significantly boost the broader market and allow the S&P 500 to break 4200.

The Week Ahead

Looking ahead to the coming week, we have a few key events to keep an eye on. 

Berkshire Hathaway held its annual shareholder meeting over the weekend. Historically, Buffet’s comments generate a short-term bullish aura for stocks. However, the focus will quickly shift to the debt ceiling on Tuesday, when House and Senate Republican leadership meets with the White House. I expect any positive momentum from the Buffett headlines to be counteracted by concerns surrounding the debt ceiling.

Wednesday and Thursday, CPI and PPI are released. Fed messaging suggests a June pause is possible if the data permits it. Core CPI will carry the most weight, and the consensus is 5.5%, down 0.1% from last month. While analysts are not looking for much, it is unclear whether we’ll see a decrease in core. On one hand, last month’s PPI continued its streak of downward readings, which bodes well for a decrease in CPI. On the other hand, many companies’ revenue beats this quarter were driven by price increases, which are inflationary.

Finally, on Friday, St. Louis Fed President Bullard is scheduled to speak. Although he is no longer a voting member of the Fed committee, his track record from last year lends him credibility in the eyes of the market. His insights on regional banks, inflation, and Fed policy will be closely watched and could prompt market action.

A Golden Opportunity

The debt ceiling is a looming bearish force that is likely to drag down the market. History shows us that in 2011, as the deadline grew closer and the Standard & Poor’s downgraded the U.S. credit rating for the first time ever, the S&P 500 tumbled 16%.

While Tuesday’s meeting could offer some progress on this issue, I am skeptical. Today’s political divide is much wider than it was in 2011, and any “progress” made on Tuesday is likely to be undone or amount to very little when lawmakers meet to discuss the issue in their respective chambers.

During the 2011 debt ceiling crisis, as the S&P 500 fell 16%, the GLD rose almost 20%. Gold tends to benefit as a safe haven asset when financial/paper assets are under pressure, and this time should be no different. In fact, the story is already unfolding in the price as gold is currently breaking out above its all-time high set during COVID.

To summarize, gold could serve as an excellent portfolio hedge against the debt ceiling. However, as it is currently at the top of a 3-year trading range, it may not sustain its price or momentum once the debt ceiling issue is resolved. Therefore, if you plan to buy gold as a hedge, use it as such: buy it ahead of the event, and sell it as the event unfolds or as it is being resolved.