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April 26, 2023 – Markets are being buffeted by crosscurrents. The banking crisis has come back into focus amid turmoil at First Republic. Earnings reports move individual stocks both ways. Bond market strength portends a weakening economy and slower inflation. Yet pockets of economic strength endure, mostly in the travel and leisure sectors. The net for equity investors is a standoff, one likely to endure for some time amid persistent rotation of leadership.

//  by Tower Bridge Advisors

It was a wild day yesterday with several strong moves relative to earnings, a wild ride for First Republic Bank, the regional bank most people see as the stress point within the banking system, and a sharp rally in bonds. The major averages were all lower. After the close, solid earnings from Microsoft# reduced some of the fear. Futures point to a more muted market this morning.

Let’s start with First Republic. On Monday, its stock rose in anticipation of an earnings outlook that would clearly set the path for survival and ultimate recovery, but its report after the close of business Monday showed that deposits in the first quarter fell dramatically even as they began to stabilize by quarter’s end. When rumors started to emerge that First Republic was looking at the possibility of selling a large package of underwater assets at above market prices in exchange for equity warrants, investors fled. Volume yesterday exceeded the total number of shares outstanding. I am in no position to opine whether First Republic can survive or not. What I can say is that no major bank is likely to be a savior and the crisis comes a week before the FOMC meeting that will consider another Fed Funds rate hike. Before this week, the overwhelming consensus was one more hike was in order. First quarter GDP, coming later this week, will show continued growth. Inflation remains sticky. Leisure travel is still robust.

There are contradictory signs as well. Trucking activity has weakened considerably over the past six weeks. That was demonstrated to the market via United Parcel’s# weak earnings report yesterday. Existing home sales continue to slide and of course, there are obvious stress points within the banking system. Contagion might be dismissed by some but clearly can’t be ruled out. Should First Republic not survive, focus will move to the bank deemed next most likely to fail. Then there is the bond market. In early March, the yield on 10-year Treasuries rose above 4%. Now it is 3.4%. 2-year Treasury yields exceeded 5%. They are now 3.9%. Clearly, that is inconsistent when the Fed speaks that rates need to march higher and stay there for a long time. Markets strongly suggest that both the economy and inflation are weakening. Granted, backward looking data shows ongoing strength. Nothing better exemplifies that than the 3.5% unemployment rate.

Employment data series are notoriously lagging indicators. Companies don’t lay off workers before sales slump; they respond afterwards. All the tech layoffs we have been reading about are in response to an enduring deceleration of revenue growth, but there is one labor indicator that isn’t lagging. It’s continuing unemployment claims. These represent the numbers of Americans collecting unemployment checks who can’t find a job. In September, that number was under 1.3 million. Today, it is well over 1.8 million and rising. For the past 50+ years, every time claims have hooked up in similar fashion, a recession was imminent.

The bond market agrees. The stock market doesn’t. Earnings estimates reflect a slowing economy but not a recession. Most of the weakness this earnings season to date has come from one-off situations, but there are stress points appearing. I mentioned UPS earlier. Energy stocks, the leaders last year, are giving ground amid weak prices and soft demand. China’s reopening alone isn’t going to compensate. OPEC+ has responded by lowering production. While consumers are still spending, the mix is starting to shift more toward essentials and less to discretionary items. Electronics are a notably weak category.

It remains a mixed picture on the pricing front as well. Home prices have stabilized in many markets. There are fewer buyers and fewer sellers. but the balance has led to price stability. Consumer staples leaders like Procter & Gamble# and Pepsico report both higher sales volumes and little resistance to price increases. Inflation doesn’t die quickly.

All of this leaves everyone in a quandary. Federal Reserve officials must weigh enduring inflationary pressures against stress in the banking system and accelerating pockets of economic weakness. Earnings season once again shows companies beating forecasts while tempering future outlooks. The standoff is likely to be reflected in the stock market until there is further resolution. Can First Republic survive? When will the Fed rate hiking cycle end? Is there going to be a recession in the back half of this year? Until there is better clarity, stocks are likely to remain within the same trading range they have been in for most of this past year. The leadership to date has come from the big tech companies. It is unlikely they can repeat Q1 performance without a reacceleration of revenue growth. Staples stocks, like the aforementioned Pepsi and P&G have already rallied as investors reshape portfolios for tougher times ahead. Healthcare has been a mixed bag. The drug companies have done well but many others are still feeling the downside of deceleration of Covid related activity like testing. Economically sensitive parts of the market, like rails, and manufacturing are unlikely to lead until there are signs of an economic trough. No one wants to touch the banks in the middle of a storm.

Over a decade of easy money gave investors a free ride as asset prices swelled amid a sea of free money. The Fed has reversed course and the possibility that it can remain tight for too long isn’t trivial. All historic indicators now say recession is around the corner. I believe, from 30,000 feet above, investors accept that, but when it hits home directly, as it did for UPS yesterday, there could be additional pain. However, let me put that in context. Despite a drop of about 10% yesterday in conjunction with earnings, UPS’s stock is still up about a percentage point year-to-date. In other words, the false optimism was smacked by harsh reality yesterday resulting in a stalemate. Perhaps that is a great example of what lies ahead. When too much optimism creeps in, there is a correction. When markets get too pessimistic, bargain hunting returns. It’s been a standoff for a year, one likely to continue for several more months.

Today, Melania Trump is 53. Carol Burnett reaches 90.

James M. Meyer, CFA 610-260-2220

Additional information is available upon request.

Tower Bridge Advisors manages over $1.7 Billion for individuals, families and select institutions with $1 Million or more of investable assets. We build portfolios of individual securities customized for each client's specific goals and objectives. Contact Nick Filippo (610-260-2222, nfilippo@towerbridgeadvisors.com) to learn more or to set up a complimentary portfolio review.

# – This security is owned by the author of this report or accounts under his management at Tower Bridge Advisors.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only. It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Filed Under: Market Commentary

Previous Post: «April 2023 Webinar - Banks, the Economy and Valuation April 2023 Economic Update – The Banks, The Economy and Valuation
Next Post: May 12, 2023 – While mega caps keep gaining steam, the average stock is now down for the year. Eight of the last nine trading sessions have been negative for the Dow Jones Industrial Average. The Fed may be done raising rates, but an all-clear signal is far off in the distance. Transitions are hard! »

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  • September 22, 2023 – Stocks fell sharply, continuing a negative reaction to the outcome of Wednesday’s FOMC meeting. While rates remained unchanged, the committee expressed a bias toward increasing rates again at the next meeting that ends November 1. In addition, the dot-plot of projections from Committee participants suggested only one (net) rate cut between now and the end of 2024. While short-term rates barely budged, yields on 10-year Treasuries rose by about 15 basis points, suggesting tougher economic conditions ahead, higher rates for longer and, by extension, lower P/E ratios. Lower P/Es mean lower stock prices.
  • September 20, 2023 – Today concludes the 2-day FOMC meeting. No change in rates is expected but investors will parse every detail of the post-meeting releases as well as comments from Fed Chair Jerome Powell. Recent data suggests both inflation and the economy are slowing. The ideal soft landing is still within reach, but it is also quite possible that the economy might slip into recession over the next few months.
  • September 18, 2023 – Markets are directionless, torn between better economic activity and an increase in storm clouds from labor unrest to China. What is crucial is the future trend for interest rates. Investors will parse this week’s FOMC meeting for clues, but probably won’t get a much clearer picture for their efforts.
  • September 15, 2023 – Auto workers are out on strike. So far, markets don’t care. They probably won’t care overall, unless the strike becomes extended. Elsewhere the public offering of ARM Holdings signals a healthier IPO market. Instacart is likely next. Traders are waking up from the late summer doldrums, but valuations, high bond yields and rising oil prices probably suggest more sideways churning ahead.
  • September 13, 2023 – Today’s focus will be on the August CPI report. The headline number will be disturbing thanks to higher oil prices, but core inflation is likely to stay muted. Bond yields have been creeping higher and are back at the top end of recent trading ranges. Any breakout to higher yields would be disturbing to equity markets.
  • September 11, 2023 – Spectrum and Disney are locked in a battle over how TV content is delivered to the home. Both want a bigger economic piece of the pie. The battle reminds us of the strike by actors and screenwriters. All are fighting for a bigger piece of a smaller pie. These battles are part of a process, one where the consumer will be the winner in the end. But before the wars end, there will be lots of carnage as economic reality sorts out those parts of the puzzle that cannot survive.
  • September 8, 2023 – The reported impending ban on the use of iPhones in Chinese government offices sent Apple’s shares reeling and infected the entire tech sector, sending stocks lower this week. While China’s government hasn’t officially commented, this news is yet another sign of the deterioration of economic cooperation between the U.S. and China. Economically, that can’t be a good sign.
  • September 6, 2023 – Stock prices remain slaves to interest rates. A spike in rates the past two days has put downward pressure on stock prices once again. Higher oil prices add further pressure. With little economic or corporate news coming that should change sentiment, the key data in the weeks ahead will focus on the pace of decline in inflation readings.
  • September 1, 2023 – We all hear about the lag effects of higher rates. That lag varies from sector to sector. When rates first started to rise, it affected home buyers immediately. But for those who financed or refinanced debt in 2020 or 2021, the impact was delayed. For some, that cheap debt is starting to come due. Over the next couple of years, debt service is going to become a bigger and bigger cost of doing business.
  • August 30, 2023 – At a time on the calendar when there is a dearth of economic and corporate data, traders look to the bond market for direction. Yesterday, yields on the10-year Treasury fell by almost 2% and stocks staged a solid rally. Trying to guess day-to-day moves in the bond market is pure folly, and thus trying to guess the stock market’s next move is equally foolhardy. Friday’s employment report could be market moving.

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