Stocks closed higher yesterday in a bumpy session as investors continued to debate the impact of the recent banking sector shakeup. Weekly jobless claims rose slightly, and GDP was revised down… the Fed is getting what it asked for.
The other shoe. As the shutdowns of Silicon Valley Bank and Signature Bank grow smaller in the rearview mirror, many are breathing a sigh of relief. To be clear, the second and third largest bank failures in US history were a very bad thing, indeed. However, the big, big fear was if the problem were to become more widespread, which, for the moment, at least, doesn’t appear to have happened. Despite this, the markets are still unsure about what to make of it and shockwaves continue to reverberate through financial sector stocks and the market in general. If you follow the markets intraday, you will see headlines like “bank fears gone,” and see financial stocks rally, but within minutes you will witness sharp selloffs followed by more headlines like “rally fades on financial sector fears,” but ultimately stocks rally into the close… no headlines. The next morning headlines read “bank fears gone, markets rally.” Yeah, those are the hallmarks of an unsure and uncomfortable market.
Yesterday, Treasury Secretary Janet Yellen was quoted as saying that “more work needed to be done” when discussing the banking system. In fact, if you pay close attention to what all senior financial system officials are saying, you will surely detect quite a bit of careful word mincing. No one has come out and said, “we’re good, no problem, nothing to see here.” The Fed, just last week, defiantly raised interest rates another +25 basis points, and many expected the move, if at least to tell the markets that The Federal Reserve System – one of the principal agencies in charge of bank regulation – believed that a crisis was averted. If the Fed had not raised rates, it may have implied that the Fed knew of some undisclosed weaknesses in the system. Still, all conjecture.
So, was a larger crisis averted? Well, maybe, but the debacle has certainly exposed a larger trend which was previously overlooked and bares some focus. Banks make money by lending out your deposits. They pay you short-term interest (in essence, borrowing from you) and lend the money out for longer maturities. Usually, there is a healthy spread due to term premium, but in the current environment, those spreads are very thin, if not, completely non-existent due to the inverted yield curve brought on by the Fed’s aggressive rate-hiking. That leaves banks struggling to maintain their net interest margins, which have been under severe pressure. How do they survive? You probably know the answer… if you have cash sitting in your local bank. They pay you next to nothing for your deposits. They have gotten away with it because we have grown used to low or no interest on checking and savings accounts. This was due to the low interest rate environment the US had since the 2008 banking crisis, The Great Recession, and the pandemic. News flash: we are no longer in a low interest rate environment. These days, a 3-month Treasury Bill will yield you 4.75% and earlier this month their yield was as high as 5%! You probably have not checked, but it is not likely that you are getting anything near that on your cash deposited at your local community bank. That is precisely why many folks have been quietly withdrawing their cash from banks and moving them to brokerage accounts in order to get the higher yields from money market instruments. Those instruments typically invest in low-volatility, short maturity instruments… like T-bills and the like, and due to the current rate environment, they are able to provide higher returns. All that cash flowing out of banks has been a strain on the banking system, and banks are struggling to stop the outflow of funds, but they are in a tough place. If they raise the yields on savings accounts, it will eat into their already diminishing margins. Those banks unwilling or unable to compete are scrambling to cover the withdrawals. Now, we are not talking about bank runs like the one on Silicon Valley Bank, but the challenge for, at least smaller banks, is real. What does this mean to us? Well, you can be sure that the Fed is monitoring this very carefully. Not just because one of their responsibilities is bank oversight, but because it is the high interest rates, controlled by THEM that is causing the stress on the banking system. The Fed may therefore find itself in situation where it must lower those rates sooner than expected, despite inflation, in order to avoid a larger crisis.
WHAT’S SHAKIN’ THIS MORNIN’
Generac Holdings Inc (GNRC) shares are lower by -3.19% in the premarket after BofA downgraded the stock to UNDERPERFOM from NEUTRAL and lowered its price target to $91 from $141. BofA cited worsening fundamentals and expects that the company will struggle to meet its own guidance figures. Potential average analyst target upside: +29.7%.
Advance Auto Parts Inc (AAP) shares are higher by +1.13% in the premarket after Barclays upgraded the company to EQUAL-WEIGHT. The reason for the upgrade, was not necessarily good performance, but in fact, its underperformance in a healthy market segment. Only 25% of analysts rate the company the equivalent of a BUY, while 70.4% have it as a HOLD, and the remaining 2.7% rate it as a SELL. Dividend yield: 5.05%. Potential average analyst target upside: +30.1%.
YESTERDAY’S MARKETS
Stocks jumped around in yesterday’s session with the recent banking sector stress still in view. The S&P500 climbed by +0.57%, the Dow Jones Industrial Average rose by +0.43%, the Nasdaq Composite Index gained +0.73%, and the Russell 2000 Index slipped by -0.18%. Bonds gained and 10-year Treasury Note yields declined by -1 basis point to 3.54%. Cryptos fell by -1.73% and Bitcoin declined by -0.85%.
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