In Friday's other data release (we wrote about the non-farm payrolls here on Friday) we learned that that bank deposits dropped $64.7 billion in the latest week. That is the 10th week in a row that deposits declined.
My concern for banks is that we have shifted from safety of deposits (a fear that was incredibly overdone) to investors examining the potential yield they can get from parking their cash in other assets. Bank deposits, which grew on an average of $500 billion per year, from 2014 through 2019, jumped $5 trillion in two years. I expect to see pressure on deposits until yields become more competitive. There will always be a gap but it is too high right now.
It is true some banks view themselves as having too much in deposits versus other forms of funding, but I don't see that as a reason to be bullish.
Cost of capital and access to capital are deteriorating for many companies, which is not good.
Fed Balance Sheet
We also learned on Friday that banks were relying less on the Fed's emergency lending programs (particularly borrowing at the discount window). That in theory is good as it indicates less pressure on banks, except it being accompanied by record drops in lending. That could signal that the decline in emergency lending usage is as much about banks shrinking their lending as it is about stabilization.
Finally, we did see stocks pop as the Fed's balance sheet increased, and now both stocks and the Fed balance sheet are shrinking a bit. Quantitative tightening, and the shrinking of the Fed balance sheet will act as a headwind for risky assets.
Oil
WTI crude jumped 8.5% last week and is 20% higher than it was as recently as March 17.
I'm normally less concerned about the inflationary risk of oil, because:
- The Fed tends to treat it as transitory, which fits my view that it is self-correcting.
- When oil prices rise because economic activity is increasing, then I think the overall economic activity can lift risky assets regardless of what is going on with inflation and bonds (the old-fashioned "risk on" trade).
but
- Oil increased largely because OPEC+ cut a significant amount of production. Yes, recession fears peaked with the so-called banking crisis and some of that has reversed, but the cut seems to have played an important role.
- We have seen problems in shipping, freight, and inventories and I believe OPEC, much closer to the demand side of the energy equation, saw disturbing trends, which supports recession fear.
Higher oil prices, for the wrong reasons, will be a headwind for the economy and risk.
Economic Data
Last week, with the exception on Friday's jobs numbers, the data was weaker than expected almost across the board, and absolutely weak in other cases.
So let's look at this chart:
This Citi Economic Surprise index tends to have sharp moves higher and lower. It makes sense in many ways as it compares data to analyst expectations.
Analysts are often reluctant to update forecasts, or just don't bother to update them (they have better things to do than tweak every expectation on every data point that is tracked by the index). So they have a built-in "lag" effect, where expectations reflect the last trend for too long.
I am very concerned that while the index is at a "good" value today, we could see it drop rapidly.
We went from soft landing to no landing in record time (five weeks of better-than-expected data). Can we reverse that just as quickly?
Earnings
Earnings season has been mixed for stocks over the past couple of years.
The first-quarter earnings season in both 2021 and 2022 were negative. 2022 was heavily affected by the shift from easy money to a tougher Fed.
A few weeks ago, it seemed easy to argue that earnings estimates (and market positioning) were too negative and it wouldn't take much to pop post earnings (Micron (MU) , which surged 8% the day after their earnings is a prime example).
It is less clear, as positioning has become more bullish and the economic outlook has started to turn, whether those conditions for nice pops on OK reports is still possible.
I'm leaning bearish on earnings, but this could be a wildcard that turns me to positive.
Geopolitical Optimism?
I see a divergence between geopolitical risks and market optimism on those risks. Whether Russia/Ukraine, China, or even the Middle East, people seem a touch too complacent at the moment.
While investors "talk a good game" on geopolitical threats, they seem to be very willing to expect good outcomes over bad outcomes even if the signs are pointing the other direction.
Bottom Line
Rates
I think we could see marginally higher yields. I think it would take a geopolitical event to create a large move to lower yields (call a large gap 25 bps or more). I see many easier paths to going 25 bps higher on yields.
So, maybe the outlook for yields is a high probability of stable to slightly lower yields, with a much better chance of a significant move to higher yields than lower yields, leading to being small bearish on Treasuries or bullish but with some options to hedge the risk.
Equities
There are too many headwinds to be constructive. On a scale of -10 to 10 where -10 is extreme bearishness and 10 is extreme bullishness, I'm about a -3 or -4. That would translate to small-to-medium underweight/short positions on equities. If it got to "medium" from small, it would be for a trade.
So I'm bearish, but not going to pound the table, but I need to see more than a week of stocks ramping to convince me that much has changed. Positive responses to mediocre earnings/outlooks would change me to bullish in a flash.
I generally like "reversion to the mean" trades, such as Invesco QQQ Trust (QQQ) up 20% year to date, versus iShares Russell 2000 ETF (IWM) (0%). Cathie Wood's Ark Innovation EYF (ARKK) at "only" 23% YTD seems low versus QQQ as well. There's obviously a lot going on, but I like some mean reversion.
I'm still dabbling with banks from the long end, but it is a tiny to small range of positioning until we see how the deposits go.
One big problem with "mean reversion" is what mean are we reverting to? So, sure, mean reversion makes sense, and I like the symmetry of year-to-date numbers, but we may well be reverting to some other mean (shorter or longer term). All these would be smallish and with an overall mildly bearish outlook.
Credit
I find it difficult to advocate for high yield (or leveraged loans) when the Russell 2000 has been so weak. Selling iShares iBoxx $ High Yield Corporate Bond ETF (HYG) , iShares iBoxx $ High Yield Corporate Bond ETF (JNK) , Invesco Senior Loan ETF (BKLN) , SPDR Blackstone Senior Loan ETF (SRLN) , for example.
Investment is OK, at best.
Munis. I like munis still here. Yeah, they trade expensive, etc., but as it is clear tax refunds are less this year than usual, we should see affluent investors continue to embrace munis. I did take some profits on closed-end fund purchases made earlier this year, and I will buy back on any dips.
Structured Risk. I like taking less risk in the space (moving up the cap structure) and am eyeing some ETFs such as Janus Henderson AAA CLO ETF (JAAA) (AAA collateralized loan obligations).
