Market Note – March 27, 2023

By Hightower Great Lakes on March 27, 2023

Fed Data Shows Rising Bank Borrowing and Lending

The Fed released H8 data and for the week ending March 15, commercial banks borrowing from the Fed increased $475 billion from the prior week, or 25%. Deposits fell $100 billion in a week and have fallen $600 billion since the Fed began raising interest rates. Despite worries around bank lending, commercial and industrial loans have grown over the past month, as have residential and commercial real estate loans.

Chart 1: Lending Higher, Deposits Lower¹

Banks borrowed an average $117 billion each night from the Fed’s discount window. Borrowing from the Fed’s new bank term funding program (BTFP) has grown from $2.4 billion in the program’s first week to above $50 billion last Wednesday alone.

The step up in borrowing reflects the Fed making these borrowing programs more attractive since the bank’s collateral assets, which loans are being made against, can now be valued at par. Banks borrow from the Fed to shore up liquidity as deposits exit, or to build up liquidity in case panic spreads. The Fed’s borrowing facilities are being used to safeguard the industry from systemic liquidity problems.

While the Fed is traditionally used as a lender of last resort, and short-term borrowing can produce a negative stigma around the solvency of banks that use it, today’s environment might be more positive that banks are tapping access to liquidity.

The underlying collateral is not at risk of defaulting. Rather, they are just holding losses due to the Fed’s extreme rate hike policy. Now that those securities can be valued at par as collateral, banks can access more liquidity.

Fed Raises 25 bps, European Central Bank Raises 50 bps

As widely anticipated, the Fed raised the federal funds rate by 25 bps to a range of 4.75% – 5% at last week’s FOMC meeting. Chairman Powell acknowledged the potential banking crisis, however, remains determined to meet the Fed’s 2% inflation target. After reaching -26 bps on Friday afternoon, the 2s/10s spread finished at -40 bps. High Yield spreads finished the week at +542 bps, the widest point since last September.

European Central Bank President Lagarde is keeping a hawkish tone, while the U.S. Fed is indicating a more dovish tone. Lagarde noted that there is no tradeoff between financial stability and price stability – the goal remains to bring down inflation to 2%.²

Both central banks are making a concerted effort to build confidence that the banking sector is strong, but Chair Powell acknowledged that, “it’s too early to say,” what effect the bank challenges will have on the economy, but a path to a soft landing, “still exists.”³

Overall, Silicon Valley bank was insufficiently risk-managed with high concentration risk and poor liquidity oversight. Credit Suisse has been struggling for a while, with contracting profits and less regulatory capital oversight in Europe.

Chair Powell’s balanced tone was also reflected in a dot plot that remains at 5.1% – indicating one more 25 bps rate hike, given the current fed funds target rate is 4.75-5.00%. A consistent division exists between market rates and Fed expectations, as Powell noted that, “participants don’t see rate cuts this year,” though markets are pricing in an 80% chance for 100 bps of rate cuts by year-end.

Large banks are going to take market share. Valuations are cheap amid the volatility, and the bank index is priced below book value. Earnings will be impacted with lower interest income, but deposits will not be an issue.

Smaller regional banks may still be challenged as they are more highly concentrated and exposed to potential deposit outflows. Therefore, they are looking to shore up liquidity and protect themselves in case of a run on the bank.

Chart 2: Bank Earnings Expectations Remain High, Valuations Back to 2020 Levels⁴

Commodity Prices Near Recent Lows

Crude oil, lumber and copper are a few commodities that are macro-sensitive and have fallen in the past year. We closely followed the higher energy costs that spiked in mid-2022 and crude oil is now (only) 14% higher than pre-pandemic. Similarly, lumber last year was up 260% vs. pre-pandemic, and it is now just 1% higher than pre-pandemic prices.

Chart 3: Commodity Prices Lower in the Past Year, Supporting Fed Goals and Corporate Costs⁵

Lower commodity prices will benefit purchasing companies seeking to manage lower input costs. For commodity producers, there remain long-term tailwinds across the valley, in anticipation for a return to strong economic growth and lower interest rates. Supply remains limited and growth remains healthy across many industries, including energy, homebuilding and semiconductors.

Equity Performance Rotation Warrants a Stock Pickers’ Market

Year-to-date, growth stocks are outperforming value stocks, a material rotation from 2022 value outperformance. We continue to advocate a barbell approach toward investment opportunities in the market. Over the past two years, given all the volatility from Russia-Ukraine, Fed policy, re-openings and supply challenges, value and growth index returns are nearly flat.

Chart 4: Growth Outperforming Value Year-to-Date⁶

PMI services expansion is accelerating. February numbers were well-ahead of expectations, including the strongest expansion of new orders since November 2021. On the contrary, the PMI Manufacturing survey has remained in contraction for four consecutive months. Prices expanded in February within both PMI services and manufacturing surveys.

Another economic indicator, which supports the overall macro strength is the tight labor market. There are 3.0% more goods-producing jobs and 3.1% more service-providing jobs than this time last year.

There were less than 200,000 initial jobless claims last week, and the year-to-date weekly average is 195,000 initial claims. The average weekly initial claims over the five years 2015-2019 were 245,000 – 26% higher than today’s weekly levels.

Themes that we anticipate for Q1 earnings include easing currency headwinds, lower freight and commodity costs, and improved supply chains. As a result, we expect margins to hang in better-than-expected and selection to be important in portfolios. Numerous companies have implemented cost-cutting programs, in addition to a combination of lower costs and inelastic pricing power.

It is very much a stock-pickers’ market, and companies with exposure to U.S. consumers must execute. Nike (NKE) recently beat top and bottom lines, noting higher sales and significant progress working down excess inventories.

Another company that reported earnings last week, General Mills (GIS), also beat top and bottom lines, driven by its strong price/mix, which contributed to +16% y/y organic sales amid flat volumes.

Technology and communication services companies, like Meta (META) and Disney (DIS), are growing end-market exposures, restructuring and slashing costs. Another example of executing on growing end markets is within the semiconductor industry, which McKinsey projects to become a trillion-dollar industry by 2030, driven by automotive, data storage and wireless industries.

We are positive on housing. With lower market interest rates and significant pent-up demand, existing home sales grew +14.3% m/m in February. If rates come down, housing goes higher. There is a five million housing shortage, homebuilders have underproduced and commodity costs are down.

Finally, energy company valuations have pulled back and we see opportunities amid the lower, yet still elevated, commodity prices. The significant risk to a longer-term cycle has been a capex explosion from overzealous management.

This has not materialized. Lower prices and dried-up capital markets are keeping the energy pipeline in a strong position for elevated cash flows and capital discipline.

The Week Ahead

Earnings – Tuesday: WBA, MU, MKC. Wednesday: PAYX.

Economics – Tuesday: Consumer Confidence (March). Thursday: Q1 GDP (Final). Friday: Core PCE (February), Chicago PMI (March), Michigan Sentiment (March).

Return for Selected Indices⁷

Click here to read last week’s Market Note (3/20).

Disclosures

OCIO is a group of investment professionals registered with Hightower Securities, LLC, member FINRA and SIPC, and with Hightower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through Hightower Securities, LLC; advisory services are offered through Hightower Advisors, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.

All data and information reference herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary, it does not constitute investment advice. OCIO and Hightower shall not in any way be liable for claims, and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice.

This document was created for informational purposes only; the opinions expressed are solely those of OCIO and do not represent those of Hightower Advisors, LLC, or any of its affiliates.

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¹ Source: FactSet (chart). As of March 26, 2023.

² Source: Bloomberg. As of March 24, 2023.

³ Source: CNBC. As of March 22, 2023.

⁴ Source: FactSet (chart). As of March 26, 2023.

⁵ Source: FactSet (chart). As of March 26, 2023.

⁶ Source: FactSet (chart). As of March 26, 2023.

⁷ Source: Bloomberg. As of March 26, 2023.