by Franklin J. Parker, CFA
The Summary
- This is a big data week for markets. The Federal Reserve meeting concludes on Wednesday with a rate decision and commentary. While a 0.25% hike is baked-in, investors will listen very closely to Powell’s remarks about the path of rates for the rest of the year, as well as the Fed’s economic outlook (a recession: will there/won’t there).
- About half of the S&P 500 companies have reported earnings. As it stands companies are making about 4% less money than they did this time last year. The big story is Amazon’s blowout quarter — if Amazon’s earnings were excluded from the S&P 500 results, the average decline in profit would be 5%! Overall, the earnings contraction is mild, but CEOs are also cutting outlooks for the rest of the year — not a good sign.
- This week we also see employment data, which is an important economic signal, along with Factory orders. Today’s Purchasing Manufacturer’s Index showed further declines last month, which is an ongoing concern. Last week we got a read of US GDP, which grew just over 1% in Q1. Digging into the forces driving that GDP print, it is clear that consumers are the main drivers of GDP growth. Should consumers begin to stumble, an economic contraction would likely not be far behind.
The Details
First Republic Bank became the second-largest bank failure in US history over the weekend.
I have surveyed the balance sheets of many regional banks, and this problem is more widespread than regulators would like us to believe. Many banks are suffering from serious losses that are unreported, due largely to their holdings of long-dated US Treasury bonds as well as US agency bonds.
This isn’t necessarily an immediate problem, but it significantly curtails lending and puts many of these banks at a disadvantage to weather an economic storm.
Looking at the earnings contraction, the contraction in manufacturing, and the credit/banking contraction, this has all the hallmarks of a prelude to recession with one caveat. The US consumer has remained quite strong. Unemployment would be the next domino to fall, then we should expect to see consumer spending slow.
Of course, you wouldn’t think much was wrong at all looking at the recent run-up in markets. I would caution against chasing that return, however. It is not uncommon for markets to run higher leading into a recession (as this week’s chart of the week shows).
Chart of the Week
This week’s chart shows the behavior of stocks leading into the last four recessions. As we can see, markets do not tend to sell off until a month or two ahead of the actual start date of the recession. 2008 is a notable exception, when markets topped out, then topped out again, just 60 days before the start of the recession. The point is, markets are not great at pricing-in recessionary signals until just before it hits. That is both good news and bad news. It takes some psychological wherewithal to trust the data when markets are running higher. On the upside, it gives alert investors plenty of time to position themselves for the coming storm.
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