By Cory McPherson | May 2023
The week of April 24th saw many of the mega-cap stocks report earnings, with most of them posting impressive first quarter results that led to their stock prices moving higher. Microsoft, Alphabet (Google), and Meta (Facebook) all saw significant gains after their release of first quarter earnings. While Apple does not report until Thursday, May 4th, it’s stock was able to ride the wave higher as well. The one stock that did not see the big gains after reporting its earnings was Amazon. When the initial report came out showing results that beat expectations, the stock went up over 10% in after-hours trading. But by the time the market opened the next day, the stock was down over 2%. This was due to company executives during their conference call giving a more cloudy outlook of what was to come for the company and the economy as a whole.
While the big gains from a select few companies propelled the market higher, broad participation in the rally was absent. Market breadth continues to weaken and remains a concern.
The chart above compares small-cap stocks (black line) and technology stocks (red line) since the beginning of the year. You can see the vast outperformance by technology stocks since March, being carried mostly by a select few.
The market value of the S&P’s two largest stocks, Apple and Microsoft, is now at 14% of the index. That is the highest in history. The ten largest stocks of the index are responsible for almost 90% of the gains in the S&P so far this year. Bull markets do not historically begin with such limited participation. We want to see this change before looking to take more risk in the market.
The chart below is another way to measure market breadth. It has the S&P 500 at the top, along with its 50-day moving average (blue line) and 200-day moving average (red line). Since the bank failures in March, the S&P has been able to rally back to near its February high. Below, though, shows that wide participation has not been there. The middle chart is the percentage of stocks above their 200-day moving average, which has been trending down since February. The bottom chart is the percentage of stocks above their 50-day moving average, which has actually trended down since December. You want to see those percentage of stocks above their moving averages rise with the market, signaling more participation in the market rally.
Regional Banks Continue To Struggle
Early on Monday, May 1st, regulators seized First Republic Bank, making it the second largest bank failure in U.S. history. Our previous newsletter reviewed the failures of Silicon Valley Bank and Signature Bank in March and made mention of the Silicon Valley Bank failure being the second largest in history. Just a few weeks later and another bank failure has topped it. That means 3 of the 4 largest bank failures in this country’s history have occurred in a matter of weeks.
Like SVB, First Republic was also a California-based regional bank focused on serving high net-worth clients. Many of the problems were the same, including a high proportion of uninsured deposits. The collapse began on April 24th during the company’s 1st quarter earnings call when the bank revealed more than $100 billion in deposits had been withdrawn from the bank.
Most of the assets and deposits in the bank were quickly sold to JP Morgan after the FDIC takeover. The largest banks of the U.S., including JPM, recently deposited a total of $30 billion into First Republic in hopes to keep it solvent, but it was not enough. With the JP Morgan acquisition, the largest U.S. bank gets even larger as it receives $92 billion in deposits, $173 billion of loans, and $30 billion of securities.
The recent banking crisis has now led to a tightening in credit standards for bank loans. The chart below shows credit standards among developed nations banks are at levels not seen since 2008. This is mostly being driven by U.S. and European banks.
As discussed in our previous newsletter, if banks become more reluctant to lend money, the economy can come to a halt rather quickly.
What many are now wondering is how many more failures will we see in the banking system? Government officials, along with JP Morgan CEO Jamie Dimon are attempting to quell fears about any problems with the system. Dimon was quoted as saying, “This part of this banking crisis is over.” Investors, though, are still weary of jumping into regional bank stocks despite the large drawdown. The chart below is of a regional bank exchange-traded fund.
It had its waterfall decline in March as the first 2 banks failed. What we’ve found interesting is that while the overall stock market rallied since then, the regional banks have not. It has gone sideways with a tilt to the downside and recently has made new lows. We do not believe this to be a good sign for the market or the economy as a whole.
Federal Reserve Policy
The Fed will be making their next interest rate decision on Wednesday, May 3rd. It is widely expected and priced in that the Fed will raise rates again by 25 basis points (0.25%). Much of the market reaction for both stocks and bonds will depend on what Chairman Powell has to say after the rate announcement. The Fed remains in a tough position as they continue to attempt to bring down inflation without causing too much harm to the economy. Many market participants are betting on interest rates being cut by the end of the year, which they believe would provide relief to markets. So far there has been no signal from the Fed that they are projecting that. We believe that if the Fed does eventually become forced to cut rates due to economic conditions, that it would not be positive for the stock market.
With the upcoming debt ceiling limit, the longer it goes unsettled, the more uncertainty it adds to the market. So far stocks have not shown a concern that the U.S. will default on its debt or receive a credit downgrade. Most believe something will get settled, most likely in the final hours. No matter what happens with the debt ceiling, though, it won’t solve the fiscal problems this country is facing and will continue to face. According to the congressional budget office (chart below), Federal debt is projected to rise from 98% of gross domestic product (GDP) to 118% by 2033. Over that period, the growth of interest costs and mandatory spending outpaces the growth of revenues and the economy, which will continue to drive up the debt. As those factors persist, the debt will reach 195% of GDP in 2053.
While most report on the current debt load of around $31 trillion, that number does not account for future entitlement spending. If that were factored into the present value of the debt, the total number would be closer to $200 trillion. We get asked all the time why the federal debt never seems to matter to the stock market. At some point it will, not because of a certain number, but because it will lead to other bad outcomes in the economy, affecting the revenues and profits of corporations.
In looking at our indicators, and what we see in the economy, we believe it is prudent to remain cautious at this point. We are uncertain that a new bull market has begun and the bear market that started in 2022 is complete. While some of the technical evidence has improved this year, other parts are not lining up like they historically have to mark an important buying point in the market. We are ready to change strategy as the evidence unfolds. If we see this rally continue, we’ll want to see more participation and wider breadth to get more excited about it and will look for our indicators to confirm each other. Until then, we’ll remain patient and wait for better opportunities.
Cory McPherson is a financial planner and advisor, and President and CEO for ProActive Capital Management, Inc. He is a graduate of Kansas State University with a Bachelor of Science in Business Finance. Cory received his Retirement Income Certified Professional (RICP®) designation from The American College of Financial Services in 2017.