Central banks and large private banks have come to the rescue. As rumors and speculators attacked Credit Suisse (which remains a well capitalized bank, but with profitability issues) the Swiss National Bank offered 50bn CHF to make sure that there is no liquidity crisis. And when this did not stop the flight of depositors, the Swiss authorities did everything they could, including changing the law so that UBS could buy it for a small fraction of its value over one weekend. At the same time in the US, a consortium of eleven large banks agreed to deposit 30bn $ to First Republic Bank, which had also seen outflows of depositors and an attack on its shares and bonds. A banking crisis might have been resolved at the very start for now, as memories and lessons of 2008 ignited the immediate response of the public and private sector. But the issue is that the current sentiment within the banks is not positive for the flow of credit to the economy, which is perhaps the most significant factor for economic growth. The US regional banks account for more than 30% of corporate lending in the US and primarily to the SMEs (small and medium size companies) which is the blood of the economy. A recession that could have been avoided, maybe now is a certainty in the coming 6-9 months.
Funding strains remain in the banking system, despite the efforts to backstop deposits and shore up confidence in the wake of SVB Financial and Signature Bank's collapse. Bloomberg cited Fed data that showed $152.85bn was borrowed from its discount window in the week ended 15-Mar, up from just $4.58bn in the prior week. But the scariest part is that this amount was even larger than the record high of $111bn during the 2008 financial crisis. The balance sheet of the FED has ballooned again and all of its efforts to shrink it in the face of combatting inflation has been in vain for now.
Equities had a rough week, with the exception of Nasdaq which rose by 4%. The S&P500 finished also with gains albeit much smaller (+1.4%) helped by the large weight of Technology in its composition. Europe fell by more than 4% on average, with Swiss stocks finally out-performing with a fall of about 1.5%. In terms of sectors, as already mentioned, Technology was the big winner with 4% gains, followed by the defensives which posted small gains in an overall negative environment (Healthcare +1%, Utilities +2%). The worst sectors was Financials (-6%) and Energy (-8%).
Bonds were the winner of the week. Despite the volatility around the ECB meeting and the profit taking every time equities tried to rebound, government bonds posted solid gains. The 2-year US yield dropped a whopping 135 bp from the recent high almost one week ago, to 3.85% from 5.10%. The 10-year US yield dropped to 3.40% from 4.00%, which translates to about 3% gains in price just in a matter of few days. Grman bonds also rose, despite the ECB rate hike. the 10-year German yield is now closer to 2.10%, down from 2.70% a week ago. Our thesis that bonds should do better than equities for the foreseeable future still holds.
The ECB chose the "do-not-panic-the-markets" path and raised interest rates by 50bp, as expected before the recent developments. However, they removed from the announcement the reference that rates will have to be raised in the next meetings, adding that their forecasts on inflation and growth might have to be revised in light of the events of this week. What we also learned from the press conference it that "3 or 4" Governing Council members did not support the Executive Board proposal of a 50bps rate hike, which was adopted by a "large majority" in a rather record time. What we can conclude is that most probably we have seen the peak of interest rates in this cycle, as the recent banking crisis must eventually have an impact on the flow of credit from banks to corporations and households, affecting negatively the economies and bringing consumer prices down, due to lower demand for goods and services.
The FED is probably going down the same path as the ECB. Expectations for its decision on Wednesday range from a hike by 25bp to a cut (!) of 25bp, but given the latest inflation data as well as the rush to save the failing banks, the FED will most likely opt to go for the 25bp(pre-announced) hike. However, the future guidance and the comments of Mr. Powell will be the important elements to watch, in order to determine whether we are indeed at the end of this interest rate increases cycle.
The US consumer inflation (CPI) confirmed the downtrend but also the slow-down in the dis-inflation process. The monthly change was 0.40%, which brought the annual rate of change down to 6%, from 6.4% in January. We see that inflation is continuing its downtrend from the peak of 9% in June, but the recent monthly changes of 0.4% and 0.5% represent a relative spike. According to our calculations, if the monthly increases drop back to 0.30%, which is the average of the last few months, then the headline number can drop below 4% by early summer. However, after that it is more difficult to move further down, based simply on the "base effect", which we have been highlighting as a major force for inflation to go down in the first part of 2023 (i.e. a high comparison base with early 2022). The Core CPI dropped only slightly to 5.5% vs 5.6% the previous month, as prices for services (rents, restaurants, travel etc) continue to move higher.
The February US housing market data improved. The NAHB housing market index rose to 44, higher than expected, but it is still at very low levels. As a comparison, the index was at around these levels in April of 2020 when the Covid19 pandemic broke. During the 2008 crisis the index had fallen however to levels below 20, but then the housing market was the real issue that brought banks down. In other February data, the Building Permits and Housing Starts all rose more than expected. The recent drop in mortgage rates is helping the housing market slightly recover from depressed levels.
Oil prices fell below 70$, to a low of 67$ as the current crisis points to a recession in the coming months. As we are moving away from winter, demand is also seasonally affected to lower levels, leaving oil prices vulnerable to further downside.
Chart of the Week : European Healthcare is entering again the most attractive buying zone in a decade.
The above chart shows the Price-to-Earnings ratio (P/E) of the European Healthcare sector for the last 10 years. The P/E is one metric of how cheap or expensive a stock or a sector is. As seen in the chart, the sector's P/E is now back close to the lowest levels of the last decade with the downside looking rather limited. The red rectangle shows the range of the lowest valuations for the last 10 years, with the lowest level representing about 5% lower levels from the current. The sector has undeperformed this year as investors started the year with the optimism that Europe (and the US) will avoid recession and chose to sell the defensive stocks in order to buy the riskiest and the ones which are more sensitive to the economic cycle. But the latest events might challenge the notion that a recession can be avoided. It looks like European Healthcare stocks are very attractive again and could offer protection if the situation worsens. They also come with decent dividend yields of around 3% on average.
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• Sources: Chart of the Week : Factset