Ameriprise Financial Inc.
03/27/2023 | News release | Distributed by Public on 03/27/2023 13:32
Volatility in Regional Banks Could Impact Multiple Sectors of the Economy
Despite ongoing pressures across the banks, broader U.S. stock averages finished last week higher. Both the S&P 500 Index and NASDAQ Composite finished in the green for the second straight week, gaining +1.4%, and +1.7%, respectively. The Dow Jones Industrials Average rose +1.2% in the prior week, while the Russell 2000 Index gained +0.5%. In addition, Growth outpaced Value for the fifth straight week. This has contributed to the growth-heavy NASDAQ Composite rising roughly +13% this year and helping the S&P 500 hold onto gains made earlier in the year (higher by over +3.0% year-to-date). Conversely, the Dow and Russell 2000 have lost traction over recent weeks, as both indices are now lower for the year. With Financials down nearly 13% over the last month, the sector has recently anchored broader index performance.
The epicenter of market focus continues to reside with the banks. The KBW Bank Index lost 0.5% last week, sliding lower for the third consecutive week. In addition, the group of banking stocks is down nearly 29% in March and on pace for their worst monthly performance since January 2009 (basically during the heart of the Financial Crisis). For some context, the S&P 500 is roughly flat for the month, while the NASDAQ is higher by over +3.0% in March. In our view, much of the selling pressure on banking stocks this month has remained relatively contained (for now). While this broader stock resiliency is worth noting, investors are rightfully anxious and nervous that spillover effects are usually delayed, particularly if banking stress continues for an extended period. Simply put, regional banks are the lifeblood of the U.S. economy. According to BCA Research, U.S. banks with less than $250 billion in assets account for roughly half of the country's Commercial and Industrial (C&I) lending. These banks also account for roughly half of the mortgage and commercial real estate lending in the U.S. Ongoing stress in smaller regional banks should be expected to flow through to the real economy through reduced lending, which could lead to less manufacturing and services activity, job growth, and overall consumer and business spending. The significance of smaller regional banks cannot be understated. Therefore, it is in the best interest of the industry itself as well as regulators to restore confidence as quickly as possible. Headlines for the banking group moved fast last week. Interestingly, key developments started and ended the week, not in the U.S. but in Europe. The shotgun wedding between UBS and Credit Suisse at the start of the week, two of Switzerland's largest global banks, was meant to help calm contagion fears. But by the end of the week, Germany's Deutsche Bank saw its credit default swaps (a form of insurance for bondholders to protect against company default) jump higher. While concrete explanations for the CDS move were lacking, central banker rate increases last week and continued selling pressure across the banking sector on both sides of the Atlantic fanned the flames of contagion risks. Back in the States, New York Community Bancorp agreed to buy most of Signature Bank's assets. And a buyer for Silicon Valley Bank had still not emerged as of Friday, but over the weekend, First Citizens agreed to take over all deposits and operate its 17 branches.
Markets Modestly Higher Last Week; Treasury Volatility Continued
Lastly, this week's economic highlights will be March Consumer Confidence, February Pending Home Sales, a final look at Q4'22 U.S. GDP, and February PCE data (the Fed's preferred inflation gauge). But front and center for the market will be ongoing developments across the banking sector as well as regulator responses to any potential frictions that arise.
The epicenter of market focus continues to reside with the banks. The KBW Bank Index lost 0.5% last week, sliding lower for the third consecutive week. In addition, the group of banking stocks is down nearly 29% in March and on pace for their worst monthly performance since January 2009 (basically during the heart of the Financial Crisis). For some context, the S&P 500 is roughly flat for the month, while the NASDAQ is higher by over +3.0% in March. In our view, much of the selling pressure on banking stocks this month has remained relatively contained (for now). While this broader stock resiliency is worth noting, investors are rightfully anxious and nervous that spillover effects are usually delayed, particularly if banking stress continues for an extended period. Simply put, regional banks are the lifeblood of the U.S. economy. According to BCA Research, U.S. banks with less than $250 billion in assets account for roughly half of the country's Commercial and Industrial (C&I) lending. These banks also account for roughly half of the mortgage and commercial real estate lending in the U.S. Ongoing stress in smaller regional banks should be expected to flow through to the real economy through reduced lending, which could lead to less manufacturing and services activity, job growth, and overall consumer and business spending. The significance of smaller regional banks cannot be understated. Therefore, it is in the best interest of the industry itself as well as regulators to restore confidence as quickly as possible. Headlines for the banking group moved fast last week. Interestingly, key developments started and ended the week, not in the U.S. but in Europe. The shotgun wedding between UBS and Credit Suisse at the start of the week, two of Switzerland's largest global banks, was meant to help calm contagion fears. But by the end of the week, Germany's Deutsche Bank saw its credit default swaps (a form of insurance for bondholders to protect against company default) jump higher. While concrete explanations for the CDS move were lacking, central banker rate increases last week and continued selling pressure across the banking sector on both sides of the Atlantic fanned the flames of contagion risks. Back in the States, New York Community Bancorp agreed to buy most of Signature Bank's assets. And a buyer for Silicon Valley Bank had still not emerged as of Friday, but over the weekend, First Citizens agreed to take over all deposits and operate its 17 branches.
Markets Modestly Higher Last Week; Treasury Volatility Continued
On the week, Communication Services (+3.4%), Energy (+2.3%), and Materials (+2.1%) led the S&P 500 higher, while Real Estate (down 1.4%) and Utilities (down 1.2%) weighed on performance. Ongoing volatility across U.S. Treasuries left prices modestly higher for the week. The 2-year U.S. Treasury yield settled at 3.77%, down substantially from its top of over 5.0% this month, while the 10-year yield ended the week at 3.38%. Investors have considerably raised their odds that the Federal Reserve will likely need to cut rates this year, contributing to a sharp decline in Treasury yields this month. On that point, roughly 75% of the U.S. Treasury curve is inverted today. As Bespoke Investment Group noted, all seven points on the Treasury curve with a perfect track record of forecasting a recession are inverted today. And all eighteen points having the best track record of predicting a recession are also all inverted. So, while a recession isn't a foregone conclusion, the Treasury curve clearly says it's just a matter of time. In addition, the U.S. Dollar Index rose +0.6% on the week. Gold ended slightly higher to finish at $1,979.00 per ounce. And West Texas Intermediate (WTI) crude gained +3.5%, closing at $69.25 per barrel, recovering some of the previous week's decline of 13%.
The Fed Continues its Focus on Inflation While Balancing the Need for Stability in the Financial Sector
Importantly, the Federal Reserve's FOMC lifted its fed funds target rate by 25 basis points to 4.75% - 5.00%, marking the ninth rate hike for this cycle and putting the target rate at its highest level since 2007. Fed officials had a complicated objective to achieve last week. On the one hand, the Fed needed to remain diligent in its inflation fight and communicate to the market that bringing down inflation remains the top priority (i.e., restoring price stability). On the other hand, officials also needed to recognize that maintaining financial stability is critical to economic growth, labor markets, and consumer/business activity.Following last week's decision, we would say Mission Accomplished. We believe the Fed did exactly what it needed to do. That is, craft a message and position that reassures markets that neither inflation nor financial stability operates in a vacuum. Fed Chair Powell stated the committee remains vigilant in fighting inflation but recognizes financial stability and the cumulative effects of prior rate hikes may require a change in strategy at some point. Bottom line: The Fed is likely nearing the end of its rate hikes for this cycle. However, the market may be ahead of itself if it believes the FOMC is close to cutting rates. And we would stress if the market is right, and Mr. Powell and company are cutting rates later this year, it would be doubtful such actions would be stock price friendly, at least at the start. In addition, the Bank of England and several other central banks across the world lifted their target rates last week, stating inflation remains the primary threat to economic stability.
Outside of central banker developments, the market remains incredibly sensitive to developments on the banking front. Regional banks closed lower last week, despite U.S. Treasury Secretary Janet Yellen saying regulators can take further actions to protect depositors. While her comments to Congress last week received mixed reactions, both Powell and Yellen reinforced their efforts to stem contagion risks around Silicon Valley Bank and Signature Bank. Each noted similar steps could be duplicated across other regional banks if necessary.
Notably, Big Tech remains investors' catch-all basket for capturing outperformance this year. Investors continue to look at Big Tech (spanning Info Tech, Communication Services, and Consumer Discretionary) for:
- A beneficiary of lower interest rates.
- A perceived opportunity once the Fed stops tightening policy.
- A mean reversion trade as many Tech/Tech-related stocks posted large declines last year.
- A safety trade, as several companies have wide moats, strong cash flows, fortress balance sheets, and secular drivers.
- The ability to weather a shallow recession with little need to access credit.
Lastly, this week's economic highlights will be March Consumer Confidence, February Pending Home Sales, a final look at Q4'22 U.S. GDP, and February PCE data (the Fed's preferred inflation gauge). But front and center for the market will be ongoing developments across the banking sector as well as regulator responses to any potential frictions that arise.
Important Disclosures
Sources: FactSet and Bloomberg. FactSet and Bloomberg are independent investment research companies that compile and provide financial data and analytics to firms and investment professionals such as Ameriprise Financial and its analysts. They are not affiliated with Ameriprise Financial, Inc.
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A rise in interest rates may result in a price decline of fixed-income instruments held by the fund, negatively impacting its performance and NAV. Falling rates may result in the fund investing in lower yielding debt instruments, lowering the fund's income and yield. These risks may be heightened for longer maturity and duration securities.
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The Standard & Poor's 500 Index (S&P 500® Index), an unmanaged index of common stocks, is frequently used as a general measure of market performance.
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