What I Care About This Week | 2023 Apr 17

by Franklin J. Parker, CFA

The Summary

• Earnings season has begun! Overall, investors expect an earnings contraction of 5% to 6%. On Friday, we saw earnings from banks, including Wells Fargo, JPMorgan, and numerous regional banks. What became clear was that the top five banks benefitted greatly from the turmoil in regional banks last month. Shares of regional banks fell sharply after their earnings. Banks have also begun building up rainy-day funds to weather a coming storm. It is another reminder that the economic outlook continues to deteriorate.
  
  
• Unemployment figures for March were a bit stronger than expected, although job openings fell below 10 million for the first time in years. We also saw inflation data, which cooled slightly (5.6% year-over-year). Investors took this as a signal that the Fed will begin slowing rate hikes, with their next meeting delivering the final rate hike for the year (of 0.25%). Markets rallied on the news, although it is not particularly good. The Fed tends to cut rates just before recessions, so watching their behavior is a good signal that the economic cycle is ending.
  
  
• The recent everything-goes-up rally is a bit of a head-scratcher. There are few reasons why risky assets should be climbing as much as they have year-to-date. That said, it is not uncommon for stocks to rally into a recession. Nothing is certain, of course, but this rally is not supported by the economic data. It does, however, provide opportunities to adjust portfolios and grow more conservative. As I have been saying for a few months now, this is the time to batten down the hatches — there is a storm on the horizon.

The Details

The US debt ceiling is still looming. What’s the big deal?

It is an open question whether the US Treasury can still pay interest payments on debt if the debt ceiling is not raised. Treasury secretaries from both parties have argued against testing it as there are legal questions as well as financial ones.

US Treasury securities are the keel of the international financial system. A default would be a severe crack in the very foundations of the financial system, and many of the consequences are unknown.

Of course, the US defaulting on her debt is a low probability event — investors have priced a 0.22% probability of that happening. Yet, the consequences are so severe (and unknown) that investors should still pay close attention and take steps to insulate portfolios.

And now is the time to be doing that. If it becomes clear that no deal will get done, everyone will be rushing for the exits at the same time. That, of course, makes it very difficult to get to safety.

Chart of the Week

With earnings season in full gear, it is helpful to review what investors think is going to happen. Remember — it is significant deviations from expectations that move markets. While some sectors are expected to do well this quarter (Consumer Discretionary and Industrials, in particular), overall the market is expected to deliver a contraction of 5% to 6% in earnings. If that happens, it would be two quarters in a row of earnings contractions. Not a good sign, overall.

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