Why This Could Be The Best Week Of The Year For Stocks
Based on the liquidity already added to the system and the deposit backstopping by the government, this could be a really big week for both stocks and bonds if Powell delivers.
A brief note…
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OK, let’s do a quick recap of where we stand right now.
Silicon Valley Bank and Signature Bank have collapsed. Several banks needed to swoop in to save First Republic from suffering a similar fate. Credit Suisse, one of Europe’s largest financial institutions, teetered on the brink before getting saved by UBS over the weekend. Inflation is still above 6%. A potential recession might still be here before the end of the year. And the Fed might be getting ready to tighten monetary conditions even further by raising interest rates again later this week.
If you take all of that at face value, it probably sounds like about the worst time to be investing in stocks. I’m going to explain why I think it might be the best week of the year to be invested in stocks.
I know it seems counterintuitive, but this has been a market that over the past year and a half has been driven by two things: the Fed narrative and the level of liquidity moving around in the financial system. In short, more stimulus & more money from the government equal higher risk asset prices. This tends to be the case regardless of the state of the economy at the time.
The best example is the 2020 COVID bear market. Stocks dropped by more than 30% in one month. The government stepped in and announced stimulus checks, small business loans, loan forbearance programs and other measures designed to keep the economy afloat. After those were announced, the S&P 500 was back to all-time highs within 5 months.
A rebound in U.S. stock prices happened multiple times since the beginning of 2022 whenever investors believed that the infamous Fed “pivot” was near. It happened during the summer, it happened again in October and it helped fuel the hot start to 2023.
In each instance, Powell said the Fed was going to continue fighting inflation through tighter monetary policy and stocks retreated again.
The point is that looser monetary conditions or even the hint that looser monetary conditions might be coming have consistently resulted in a stock price rally. I think it’s about to happen again.
The markets have already corrected their expectations for what Powell is going to do for the remainder of 2023. On March 8th, the Fed Funds futures market forecasted a 91% chance that the Fed Funds rate would finish the year at 5.25% or higher.
Today, it’s pricing in a 90% chance that the Fed Funds rate will finish 2023 at no more than 4%.
The markets have been waiting for the big Fed pivot for nearly a year. We’ll find out for certain later this week if the Fed is going to give it to them, but the markets certainly think it’s coming. Even if it won’t be quite the extreme change that many think it will be, the Fed will almost certainly be much less hawkish than they were two weeks ago given recent events.
If we assume that the Fed Funds rate is likely to peak in March, let’s take a look at the other side of the monetary policy equation - the Fed balance sheet. Powell has steadily, albeit slowly, begun winding the Fed’s balance sheet for nearly a year. That is up until last week.
The Fed suddenly added roughly $300 billion to effectively reverse all of the progress it had made since November of last year. Granted, this isn’t liquidity in the traditional sense that tries to re-stimulate the economy. This is liquidity that’s being pumped into the system to keep financial institutions simply functioning properly. The Fed is offering up its emergency lending facilities to ensure that banks can meet deposit withdrawals in the event of a run. It’s an admirable goal, even if it is one that’s potentially costly.
Regardless, it’s more liquidity that’s being added to the system and, even if it comes amid a banking sector crisis, this tends to be the type of thing that lifts stock prices.
Here’s the other thing we need to factor in. The government is effectively backstopping all uninsured deposits. One of the things that sunk Silicon Valley Bank is that roughly 90% of deposits were above the FDIC’s $250,000 insurance limit. When depositors started sensing trouble, they wanted to get their uninsured deposits out before something really bad happened and that pushed SVB to become effectively insolvent.
With the government now insuring deposits at SVB and Signature Bank, one of two things is going to happen (and quite possibly both). First, the government will step in to backstop deposits for any institution that runs into trouble in the current environment. Second, the FDIC insurance cap of $250,000 will be raised up to and potentially including all deposits held at a bank. Something to that effect may already be in the works and it may not take long to happen.
Depositors yank their funds and keep them out of the system if they feel they’re at risk. The backstopping that’s already occurring should help calm fears and keep an important source of liquidity in the system and moving throughout the economy.
In total, these steps results in 1) more liquidity in the financial system, 2) lower interest rates throughout the remainder of 2023 and 3) a greater sense of security and safety for savers and investors. This could be a big reason why the S&P 500 was up last week even as all of this was going down.
If Powell comes through this week, this could be a really big week for both stocks and bonds.
ETFs in Focus
Here’s a look at the weekly net flows/RSI matrix, where I try to get a sense of what the markets are doing relative to what investors are doing to see if there are disconnects.
Note: Most ETFs will fall above the 0% flows/AUM line because, well, ETFs take in hundreds of billions of dollar annually. So I’m looking at 1-month flows to focus on the short-term (1-week flows are too choppy to have high confidence in the results). Upper-left quadrant would identify ETFs that are performing poorly but are seeing investor money moving in. The lower-right quadrant would be ETFs that are performing well, but seeing money leaving. Both could provide contrarian opportunities. I wouldn’t call them buys or sells. Just more of a way of potentially identifying trends.
With Treasury bills (SHV) residing in the upper-right hand quadrant of this graphic, we can see that safety is in high demand. Long-term Treasuries (TLT) are also gaining new money as is the aggregate bond market (AGG) in general. It’s notable that investment-grade corporate bonds (LQD) are seeing outflows, which proves that investors are really seeking out safe havens here. The gains in gold are another signal.
Small-caps have really had a miserable couple of weeks and I suspect it won’t be long before we see money flowing out of that group too. Nothing else really stands out here, although I’ll mention it’s curious that tech ETFs (XLK) have yet to see really any inflow activity despite a 14% year-to-date return.
Instagram Post of the Week
Last week, I put up a post just covering some of the latest big ETF launches of the past month or so. It’s actually a pretty interesting and eclectic group. The Unusual Whales Democratic ETF (NANC) invests in the stocks being bought by members of Congress. The Global X Nasdaq 100 ESG Covered Call ETF (QYLE) is one of a series of new socially conscious funds using the issuer’s popular high yield covered call strategies. The U.S. Treasury 6 Month Bill ETF (XBIL) is the latest in the suite of ETFs targeting specific maturities on the Treasury yield curve. And, of course, there’s the Inverse Cramer Tracker ETF (SJIM), which shorts TV personality Jim Cramer’s on-air stock picks.
Overbought & Oversold
Overbought: GLD
Near Overbought: SHV, BND, GOVT, MUB, BITO, SLV, BIL, IVOL
Near Oversold: IWM, VNQ, FLOT, DTD, SPLV, SPHB, URA, TAN, PSP, EWC, BKLN, EWH
Oversold: IWC, XLE, XLF, BNO, USO, REMX, SPYD, RPV, AMLP, LIT, JETS, EUFN, KRE, KBE, REM, NORW, DVY, XRT
Note: Oversold/Overbought developed using a combination of RSI and Longbow dashboard.