by Franklin J. Parker, CFA
The Summary
- It’s earnings season! Some major companies report this week and they are a good bellwether for the economy as a whole. JPMorgan, Wells Fargo, BlackRock, Citigroup, PepsiCo, and Delta Airlines are all on deck this week. At the moment, analysts expect a decline in corporate profits of about 7%. In addition to understanding the health of sales, investors will be listening closely to the outlook of management for the back half of the year.
- This week we also see all-important inflation data. Economists expect inflation to be around 3.1%, down from 4.0%, which would be good news, generally. Core inflation, however, remains pretty sticky and is expected to come in around 5.0%, only down a bit from 5.1%. In addition to its effects on corporate profit margins, the concern is that consumers cannot hold up for much longer under the heavy inflation burden. Of course, inflation is also a central figure in the Fed’s interest rate decisions, and this will be the last inflation print before their meeting later this month. Markets now expect the Fed to raise rates at least once more before the end of the year.
- Markets have been in a holding pattern for the last month. I am once again reiterating my view that a recession is on the horizon, though not here just yet. All of the classic signals are there, but the “recession is imminent” signals have not yet been triggered. Until then caution is warranted, and investors may do well to stay invested but include hedges or risk-controls against severe losses in their portfolio. As always, your goals will determine the types of risk you can and cannot afford to take.
The Details
Back in March, when Silicon Valley Bank (and others) failed, I spent quite a bit time looking at the balance sheets of regional banks in an attempt to sus-out how big the problem was. What I found was very concerning.
The problem with these banks is that they are not reporting the actual value of many of their bond and MBS holdings. Because regulations allow banks to hold these types of securities as “held to maturity,” they can lose considerable value but report the same value on the bank’s balance sheet. That makes it look like the bank has more in assets than there actually is.
Banks, of course, are not eager to report these figures, so some old-fashioned sleuthing work and estimation has to be done. As it turned out, almost every regional bank I looked at had negative equity (which is when liabilities are bigger than assets) when you adjusted for the estimated losses in their held-to-maturity portfolio.
Now, banks can run with negative equity for some time so this is not necessarily a death sentence. Plus, the Federal Reserve has implemented some programs to keep the banks solvent. When their balance sheets are in trouble, however, banks curtail lending considerably. That tightening of credit can slow down economic growth. And, of course, in a crisis, that problem of negative equity can sink a bank very quickly (as we have seen).
In any event, this is something to watch. If the Fed decides to raise rates again, and tighten the money supply, we may see more banks struggle to remain solvent.
Chart of the Week
Last week we got a look at the health of the services sector (services are 70%+ of the US economy). After a steady decline through 2022, it appears that services have ticked up in the last month (in this indicator, anything above 50 is expansion). Of course, one report does not a trend make, but this is one positive economic data point.
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