Stocks had a mixed close on Friday as earnings season kicked off with a warning message from JPMorgan. Consumer sentiment is picking up again which is good for the economy but may cause dismay for the FOMC.
On balance. Remember the Fed Balance Sheet? Of course, you don’t, because it is so arcane, and interest rates are where the rubber meets the road. Besides, interest rates are much easier to monitor. You can find them on your smartphone… or you can read this market note where I wax about them to a level just short of obsessive . Some of the recent developments in economic data have suggested that inflation is on the wane, which is a really good thing on so many levels, the least of which is the potential to extend recent gains in equities and bonds. But are we setting ourselves up for a painful faceplant?
The economy is another thing that we talk about often, but many are unsure if GDP is even worth thinking about. It is, after all, calculated a quarter late, it is often revised, and it takes the word of some third-party agency to declare any declines an actual recession. That is probably why so many investors tend to skip over discussions about the economy and seek news of the markets, because it is the markets that determine, more directly, the state of our wealth. That is all true, but unfortunately, though sometimes boring, and confusing, the health of the economy is a market driver. Recessions DO have an effect on markets, so it is important to keep tabs on economic health… that is, if you want to be a step ahead.
So, what is all this fuss about a potential recession on the horizon? Last Friday, JPMorgan Chase released a real solid earnings report beating estimates, however it was quick to remind investors that there are still strong economic headwinds, implying that investors should temper their enthusiasm. If you listened to the earnings call, you would sense that the company is talking about “when” and not “if” a recession will occur. One of the factors it mentioned was Quantitative Tightening, or QT. Oh, now it’s coming back to you, isn’t it?
Remember how the Fed bought lots and lots of bonds in the open market to flood the economy with cash and keep interest rates low? They did that in addition to pegging interest rates at 0%, amongst lots of other emergency programs, to stabilize the pandemic-induced economic collapse. Good news… it worked. Like most things, when the celebration is over, someone has to clean up. Or, in this case, someone must pay the butcher’s bill. The Fed, in early 2022, held roughly $8.5 trillion in securities on its balance sheet. That was more than double what it was at the start of the pandemic. The size of the Fed’s balance sheet is directly controlled by the Fed itself. It can buy securities, which is stimulative to the economy, or it can sell securities which is restrictive. Selling securities takes liquidity out of the economy and makes bond yields rise. Of course, the Fed can also let bonds mature which serves to shrink the balance without putting pressure on the markets. When the Fed sells securities, it is considered Quantitative Tightening, which is the opposite of Quantitative Easing (QE). The Fed, if you recall, decided to start shrinking its balance sheet last year as part of its anti-inflation tightening campaign. In addition to slowing the economy, QT is also practical, because the balance sheet needs to be reduced in size to make it more manageable. As of last week, the Fed has $7.645 trillion in securities on its balance sheet. It is, indeed, lower than its 2022 record height, but it still has a long way to go to get back to pre-pandemic levels. OR EVEN the pre-Global Financial Crisis level of one half a trillion dollars. Why am I bringing this up now?
Well, with all this talk about the potential for a Fed pivot within the next 12 months, it is important to recognize that even if the Fed slows or pauses hiking, it is still actively depressing economic growth with QT, behind the scenes. Most of us don’t realize it but banks are a big part of it, and they have been warning of tight liquidity. The QT is certainly directly responsible for treasury and MBS yields remaining higher, but indirectly, they affect stock prices. Ultimately, if the QT pushes the US into a recession, stocks will end up picking up some of the butcher’s price. Check out the following chart of the Fed Securities Held Outright, to get a magnitude of the challenge that still lies ahead.
THIS MORNING’S EARLY MOVERS
Paramount Global (PARA) shares are lower by -2.88% in the premarket. The self-destructive move is likely caused by its latest opening Mission: Impossible, which underperformed box office expectations. The company will announce earnings in early August and analysts have been aggressively lowering their EPS estimates in the past 4 weeks. Dividend yield: 1.25%. Potential average analyst target upside: +18.1%.
Tesla Inc (TSLA) Shares are higher by +1.98% in the premarket after news of its first Cyber Truck rolling off the assembly line over the weekend. It is a bit late, but its finally here. Potential average analyst target upside: -17.2%. WHY IS THIS NUMBER NEGATIVE? Because the stock is currently trading higher than median average price targets of analysts. While that can be interpreted as the stock being overpriced, it does not mean that the stock will not continue to climb as analysts potentially raise price targets.
Activision Blizzard Inc (ATVI) shares are higher by +4.12% in the premarket after a US appeals court blocked the FTC’s attempt to halt its deal to be acquired by Microsoft, which is higher by +0.34% on the news.
FRIDAY’S MARKETS
Stocks had a mixed close on Friday as earnings season kicked off on a positive foot. The S&P500 slipped by -0.10%, the Dow Jones Industrial Average climbed by +0.33%, the Nasdaq Composite Index slipped by -0.18%, and the Russell 2000 Index dropped by -1.01%. Bonds fell and 10-year Treasury Note Yields gained 6 basis points to 3.83%. Cryptos fell by -4.37% and Bitcoin declined by -3.76%. The S&P ESG Index slipped by -0.01%.
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