AFSM - Market Advances On Poor Breadth

2023-05-01 21:45:00 ET

Summary

• The S&P 500 is up 8.6% so far this year, but 20 predominantly tech stocks comprise better than 90% of the index’s gains this year.
• If it were not for Friday’s advance, the Russell 2000 would have been down for the year.
• With earnings coming in generally better than expected and economic data on the sluggish but not deteriorating side, the market has held up well.

May 2, 2023

The S&P 500 is up 8.6% so far this year, but 20 predominantly tech stocks comprise better than 90% of the index’s gains this year. The fact that the market’s breadth is so poor doesn’t mean it cannot advance more, but it does mean that the advance is not particularly strong. The most extreme example of how bad breadth is, so far, can be seen by comparing the Nasdaq 100 to the Russell 2000 via their respective ETFs, with the QQQ up 21.3% through April 30, and the Russell 2000 ETF up only 0.85% in the same time:

If it were not for Friday’s advance, the Russell 2000 would have been down for the year. This means the average stock is not doing so well. There is a huge net short position in S&P futures by non-commercial traders, which typically only happens near market bottoms. It would appear that they have been shorting the market rather aggressively after the March bottom that came after the Silicon Valley Bank ( SIVBQ ) failure, which is one explanation why the last two trading days in April felt like a short squeeze. Short-squeeze-driven rallies tend to fizzle out, but typically they advance more than one can estimate ahead of time (see chart). The net non-commercial short position in S&P futures is larger today than at the March 2020 low!

The bank most similar to Silicon Valley – namely, First Republic ( FRC ) – is teetering on the brink of collapse despite efforts to save it by injecting $30 billion of deposits from major banks, as well as a $70 billion credit line from JPMorgan ( JPM ), arranged by regulators. As I write (on Sunday), the FRC receivership has not yet been announced, but there were numerous reports over the weekend that FDIC will take over the bank and sell it immediately to the highest bidder, perhaps before the market opens on Monday, which arguably is the best thing for depositors. Holders of FRC stock and bonds likely won’t be as lucky, though, as the issue is that the bank cannot be purchased in a more normal private market transaction as its hold-to-maturity portfolio has to be marked to market, which creates a huge book value hit for a potential bidder.

The bank’s portfolio does not need to be marked to market if it is sold while in a receivership, but it does come at a very high cost to FRC stock and bondholders, as they will get little if anything from the deal.

Unrealized losses in hold-to-maturity portfolios are a system-wide problem and at one point the FDIC estimated they were as high as $620 billion (chart, above). The Treasury market has rallied since SVB failed, so this unrealized loss in the system is a little smaller, but it is nonetheless sizable. Smaller banks don’t have sophisticated trading desks like JPMorgan and Bank of America ( BAC ) have, which can hedge all day, so if I were to guess, the losses are probably disproportionately concentrated in smaller banks.

With earnings coming in generally better than expected and economic data on the sluggish but not deteriorating side, the market has held up well. Still, the volatility index ( VIX ) collapsed even further, to 15.78 on Friday, which may cause some type of mean reversion sell-off in stocks starting probably at a level above 4,200 on the S&P 500 Index, which would be a new high for 2023.

Jerome Powell will hold another one of his infamous FOMC press conferences tomorrow, some of which have resulted in horrific volatility – in either direction – during the last 12 months of the fastest interest rate hiking cycle in Fed history. He needs to pause and hear the message of the bond market and reflect on the aftershocks of SVB within the banking system, which is tightening credit for him, but will he listen?

Navellier & Associates Inc. does not own Silicon Valley Bank ((SVB)), Bank of America ((BAC)), JPMorgan Chase & Co. ((JPM)) or First Republic Bank ((FRC)) in managed accounts. Ivan Martchev does not personally own Silicon Valley Bank (SVB), Bank of America (BAC), JPMorgan Chase & Co. ((JPM)) or First Republic Bank.

All content above represents the opinion of Ivan Martchev of Navellier & Associates, Inc.

Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.

Disclaimer: Please click here for important disclosures located in the "About" section of the Navellier & Associates profile that accompany this article.

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