ACTV - Will Banking Turmoil Crush Stock Prices?

2023-03-27 05:05:25 ET

Summary

• Investors were faced with more banking turmoil last week, as the cost to insure Deutsche Bank's debt soared.
• In addition, the Fed raised rates another 25 basis points, as the consensus calls for corporate defaults, recession, and new bear market lows.
• Yet the major market averages all finished higher last week for a second week in a row.
• While Wall Street is focused on banks, Main Street proves to be resilient, and stocks continue to climb the wall of worry.

Last week brought more turmoil to the banking industry, as Deutsche Bank saw its share price plunge when the cost to insure its debt against default surged, sending new shockwaves through the sector. In addition, the Federal Reserve proceeded to raise short-term rates another 25 basis points, increasing the benchmark to a range of 4.75-5%. That energized the doomsday machine with renewed calls for a credit crunch that could lead to a wave of corporate defaults, followed by a recession later this year, as well as new bear market lows. Guess what? The major market averages all closed higher for a second week in a row, as the market continues to climb the wall of worry that pessimists relentlessly build.

If the banking sector turmoil is supposed to be the canary in the coal mine, corporate insiders at regional and community banks remain undeterred, as they have been aggressively buying their own shares ever since Silicon Valley Bank was the first of three to fail. I agree with bank analyst David Feaster at Raymond James, who said last week that the drivers behind the recent failures were "idiosyncratic and not indicative of broader issues in the industry." Consumers didn't seem to flinch either, as sentiment has not taken a turn for the worse, proving this to be more of a Wall Street event than one that will meaningfully impact real economic activity. Still, there are plenty of bears on Wall Street who are clamoring for a retest of the October lows and searching for events that might instigate such a decline. Meanwhile, the economy remains resilient.

S&P Global's mid-month measure of strength in the manufacturing and services sectors for March reflected the fastest uptick in private sector business activity in almost a year. The composite index rose from 50.1 in February to 53.3 in March, which is consistent with a 2% rate of economic growth. Goods producers are seeing their first increase in production since October 2022, as supply chains return to normal and delivery times greatly improve. While export orders continued to contract, it was the smallest contraction in 10 months, reflecting a continued positive rate of change. While the rate of increase in input prices for service providers remains elevated, it was the second slowest rate since October 2020, which again is a positive rate of change. This upturn in activity is not what we see in advance of a recession.

Regardless, investors are piling into bonds on bets that a recession is right around the corner, which is further inverting the yield curve. The 2-year yield has plunged from over 5% just two weeks ago to 3.76%, which reflects expectations for multiple rate cuts before year end.

Then again, the consensus was anticipating additional rate hikes that would have pushed short-term rates as high as 6% just a few weeks ago. I don't agree with either extreme. I think the Fed can end its rate-hike campaign with last week's increase and allow the disinflationary trend already in place to bring the inflation rate down to its target.

That is why I view the recent banking sector turmoil as a positive for the economy and markets for one simple reason-it has likely forced the Fed to pull back on what was previously a far too aggressive monetary policy stance. The greatest risk to my outlook for a soft landing and new bull market has been a Fed that tightened monetary policy too much in an effort to rein in inflation. As the banking concerns fade, investors should start to refocus on earnings and what is likely to be the trough in corporate profits in the quarter ending this week.

Let me finish with a fun fact for the month of April in pre-election years, which is fun because it puts a tailwind into the sails of bulls like me-the S&P 500 has risen in 17 out of 18 such years dating back to 1950 for an average gain of 3.48%.

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