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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.

# – 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 24, 2023 – Earnings season peaks this week before winding down. The debt ceiling is approaching and soon will replace earnings as the lead story. Washington remains as split as ever, setting up a nasty battle likely to go to the proverbial 11th hour. It could be a bumpy ride in financial markets until then.
Next Post: April 28, 2023 – Japanese lunar exploration company ispace attempted a soft-landing on the moon on Tuesday, but lost communication with the spacecraft and deemed the attempt “unsuccessful.” Last week, Elon Musk’s SpaceX Starship rocket blasted off on an unpiloted flight but then tumbled out of control and exploded. SpaceX called it a “rapid unscheduled disassembly.” Let’s face it: soft-landings are very difficult and delicate endeavors. With mixed signals on the economy emerging, we hope the Federal Reserve can engineer better results. »

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  • June 7, 2023 – Stocks continue to march higher in defiance of market pundits’ forecasts for a looming economic downturn which most expect to begin this fall. Perhaps too many investors are defensively positioned, thereby making the path of least resistance higher for the time being.
  • June 5, 2023 – Last Friday’s unemployment market action surprised investors when the two employment surveys indicated opposite results. The more reliable of the two surveys, showed strong payroll employment, which could have sent the market worrying about the Fed’s reaction to the hot report. Instead, we saw a sharp rally and we suspect that there will be significantly more “soft landing” prognostications this week.
  • June 2, 2023 – Stocks traded higher yesterday following the passage of the Fiscal Responsibility Bill in the House as well as some dovish comments by a Fed Governor. Last night, the debt Bill was passed in a bi-partisan vote in the Senate. Now the Bill will go to President Biden to be signed, which will avert a much-feared debt default.
  • May 31, 2023 – Congress now has a week to pass the debt ceiling agreement. While there will be a lot of verbal whining and expressions of righteous indignation, the majority will pass a bill that is likely to have little long-term economic consequence. Once the bill is passed, attention will turn to the mid-June FOMC meeting and the increasing likelihood of yet another interest rate increase.
  • May 26, 2023 – Wednesday’s earnings announcement by Nvidia shocked markets with the speed at which generative AI is being adopted. Even regulators can’t slow it down. Every software developer now has to incorporate AI into everything. The race suddenly got a lot more heated. To win requires the fastest chips and the best software development tools. It is way too early to identify the best products that will evolve but markets yesterday were quick to identify those that have the best building blocks to get to the finish line.
  • May 24, 2023 – The latest version of the “Fast and Furious” movie series is off to a good start. But it doesn’t draw like it used too. We have seen this plot too many times. Sounds like a repeat of the debt ceiling crisis! We don’t know the exact ending but it is unlikely to be a bond default. That doesn’t mean a solution will be without consequences. Interest rates are starting to rise again and may continue after resolution as the Treasury floods the market with new bonds. This isn’t a great short-term backdrop for equities.
  • May 22, 2023 – As go debt ceiling negotiation talks, so goes the financial markets. So far, markets are sanguine, seeing the talks mostly as political theatrics. But that could change this week if no solution is in sight before we all leave for an extended Memorial Day weekend. Whether we leave Friday with a smile or a frown is anyone’s guess at the moment.
  • May 19, 2023 – As the debt ceiling concerns lessen, attention reverts back to earnings. Key retailers aren’t reporting stellar results but their stocks are taking weak guidance in stride, a sign much of the pending bad news is already discounted. That should put a floor underneath the stock market. At the same time, money keeps flowing toward the same technology names. Chasing momentum can be dangerous.
  • May 17, 2023 – Right now, stock and bond prices are slaves to the progress of efforts to extend the debt ceiling. Yesterday afternoon’s White House meeting was more productive than last week’s. Thus, futures are up this morning, but the job is far from done. An inevitable 11th hour moment lies ahead. Hopefully, a solution will emerge, but in this bifurcated Congress, risks of miscalculation are elevated.
  • May 15, 2023 – The debt ceiling approaches but markets don’t seem to care. Perhaps they are right, and a compromise solution is just around the corner. But while June 1 is only a bit over two weeks away, any compromise must pass Congress. That may not be a simple task. If no progress is apparent before Biden leaves for overseas, expect markets to start to show concern.

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