The volatile first quarter ended on a happy note for investors last week. The S&P 500 rose nearly 3.5% on the week for its best weekly performance since November of last year. Ebbing fears about the health of the regional banking system and quarter end fund buying played their part in the rally.
Whether the Fed pauses interest rate hikes when they meet again in May is likely to be a dominant conversation in the month ahead. Currently, futures say it is about a coin flip whether the central bank hikes rates 25 bps in six weeks or they take a wait and see attitude after instituting the most aggressive monetary stance since the Volcker years. It does seem we are making some progress lately in curbing inflation. First quarter earnings season will also soon kick off and analysts and investors will have their ears perked up to see what companies are saying about the current state of the economy.
There are two additional items I will have my eye on as the second quarter begins. The first is to confirm that "financial contagion" has been "contained" and not just momentarily delayed by the actions of the FDIC and Treasury Department. Banks ended 2022 with some $620 billion in unrealized losses on their held to maturity bond portfolios. Were Silicon Valley Bank (SIVB) and Signature Bank (SDNY) outliers or just canaries in the coalmine? Time will tell.
I personally am underweighting the banking sector in my portfolio. Even if SVB was a "one off", banks are likely going to have to pay more interest to their depositors which will erode margins. They also face rising delinquency and write-off rates as the country likely is heading into recession as well as an inverted yield curve. Regional banks also supply some 70% of the loans to the commercial real estate sector. This lending is likely to face more stringent credit criteria as banks reduce their risk profile, which is the last thing this already challenged sector of the economy needs at the moment.
I am also watching the growing impacts of the conflict in Ukraine and the U.S. waging a proxy war overseas. I have said from the beginning that the administration's knee jerk decision to freeze/confiscate Russian assets was going to undermine the dollar's status as the global reserve currency with substantial long-term ramifications.
The big winner of the current situation of no party seeking a peace settlement to this conflict is China. Their economy is benefiting greatly from cheap Russian oil. They are also beginning to become much bigger players on the world stage. China has gotten Saudi Arabia to accept the Yuan as payment for oil, undermining the petrodollar. China is also brokering a rapprochement between the Saudis and their long term rival, Iran, as we appear to be quickly moving to a multi-polar world.
Combined with the ESG movement and additional regulatory policies from the current administration, the country's declining influence overseas is one reason I have been increasing my exposure to the energy sector even as crude oil has pulled back in recent months. I have outlined many of these new names like EOG Resources (EOG) , Devon Energy (DVN) , Energy Select Sector SPDR ETF (XLE) and HighPeak Energy (HPK) on these pages in 2023.
Today's unanticipated announced production cut from OPEC should benefit these names and is yet another reminder of the country's declining influence overseas. It is also a heck of a way to kick off the first day of trading in the second quarter.