Monthly Archives: August 2021

Phase Two of the Fed Follies

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With Silicon Valley Bank and Credit Suisse defunct, the Fed must restore confidence in the financial sector. The historical treatment for financial instability has been lower interest rates and more liquidity. The problem, however, is that the Fed is simultaneously trying to reduce inflation. The Fed must preside over higher interest rates and less liquidity to tame inflation. Welcome to the paradox facing the Fed in phase two of the Fed follies.

During phase one of the Fed’s tightening campaign, it raised the Fed Funds rate at almost double any pace in the previous 40 years. Furthermore, they are reducing their balance sheet by nearly $100 billion a month via QT. To the Fed’s chagrin, high inflation is proving hard to conquer because economic activity remains brisk, and unemployment sits near 50-year lows. Fighting inflation requires tight monetary policy to weaken economic demand.

Phase two, unlike phase one, introduces financial instability. This inconvenient crisis drags the Fed in opposing directions. Lower interest rates and more liquidity are the keys to boosting confidence in the financial sector, but it impedes the Fed’s ability to fight inflation.

Fed Mandates

Per the San Francisco Fed:

“Congress has given the Fed two coequal goals for monetary policy: first, maximum employment; and, second, stable prices, meaning low, stable inflation.

The Fed’s Congressional mandates argue the Fed should continue to focus on inflation as the unemployment rate is at historic lows and prices are far from low and stable. Economic activity, which significantly affects employment and prices, is robust.

If the Fed were to follow its mandates strictly, there would be no phase two of the Fed monetary policy. Fed Funds would remain “higher for longer” until inflation moderates.

Decades ago, the Fed expanded its boundaries by prescribing a third mandate. The Fed believes they must also maintain a stable financial system to keep the economy’s engine, banking, on sound footing.

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Phase Zero Follies

Before phases one and two, there was phase zero. Phase zero, occurring in 2021 and the first quarter of 2022, laid the foundation for today’s difficulties. During 2021 and the first quarter of 2022, the Fed kept interest rates at zero and bought over $1.7 trillion of Treasury and mortgage assets.

As shown below, the Fed added $1.7 trillion of assets between January 2021 and March 2022. Such a five-quarter increase was more than any other five-quarter period during the financial crisis in 2008/2009. Despite rapid economic growth and wild market speculation, the Fed was turbocharging the economic engines to a degree never seen before.

Feds balance sheet

The Fed had its foot on the gas pedal despite inflation rising from 1.4% in January 2021 to 5.28% in just six months. Inflation was running at 8.5% before they decided to do something about it. Further, inflation expectations implied by markets and forecasted by the Cleveland Fed were increasing rapidly.

Had the Fed realized supply lines were crippled, and demand for goods and services was fueled by one of the most extraordinary doses of fiscal stimulus, they would have easily recognized inflation was a problem. They didn’t, and their folly results in sticky levels of high inflation today.

Furthermore, had they started raising rates and curtailed QE in early 2021, not only would the inflationary pressures lessened, but stock and crypto speculation would not have formed the bubbles they did. Lastly, pertinent to the banking crisis, a more restrictive policy would have kept interest rates lower as the confidence in the Fed’s ability to manage inflation would have been greater.

The banks were improperly hedging against loan losses and keeping deposit rates too low, but the Fed made their bed.

Phase One

A little more than a year ago, the Fed started raising rates. Nine months ago, they gradually began reducing their balance sheet. Unfortunately, both actions were about a year too late. As such, they had to be more aggressive than they would have been.

Over the last year, we warned that the Fed would raise rates until something breaks. As labeled below, soaring interest rates are breaking the banks. 

fed funds and crisis

Transitioning Monetary Policy

In Speak Loudly Because You Carry a Small Stick we gave Jerome Powell our two cents on monetary policy. Speak more hawkish and put fear into the markets. Let the markets and banks tighten financial conditions and lending standards and therefore avoid raising rates too much.

Little did we know that hours after publishing our article, Silicon Valley Bank would fail and drag the global banking sector down. Jerome Powell’s stick is now much smaller as the odds of a financial crisis are considerable.

As we share below, the Fed Funds futures market sniffed out the Fed was up against a new opponent. On March 1, the market implied a 37% chance Fed Funds would end the year between 5.25-5.50%. Some traders bet Fed Funds could be 6% or more. Only twenty days later, the market thinks Fed Funds may end up below 4% by year-end.

fed funds probabilities
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Phase Two

Phase two is the delicate balance of inflation and financial stability. The Fed must maintain credibility that its determination to fight inflation is still strong. But also convince the market it will provide ample liquidity to restore confidence in the banking system.

We are concerned that maintaining a balance between such opposing objectives is fraught with risk.

If the Fed leans too much toward financial stability, the reignition of inflation fears may scare markets. In such a case, bond yields and commodity prices will rise and further inflame the banking crisis. It will also require the Fed to take more action to stamp out inflation.

Conversely, the banking crisis can quickly spread if the Fed does not provide enough liquidity because it worries too much about inflation.

Tightening Lending Standards = Recession

As if balancing two opposing forces weren’t complicated enough, it now appears that recent bank events significantly increase the odds of a recession. Following the events of the last week, banks have no choice but to bolster their balance sheets. Consequently, they will tighten loan standards, making borrowing harder and more expensive.

The first graph below shows the strong correlation between tightening standards and corporate high-yield bond spreads. High-yield bond spreads are a good proxy for bank loans. Based on the scatterplot, a 2.5% increase in corporate bond spreads is likely. Further, the estimate may be understated as lending standards have yet to reflect recent events. The following graph highlights the robust relationship between tighter lending standards and recessions. The third graph shows Leading Economic Indicators have declined for 11 straight months. 11 consecutive months of monthly declines in the indicator have never been seen without the economy being in or heading into a recession.

bb yields and lending standards
lending standards and recessions
lei and recessions


In the longer run, stocks are fraught with risk.

If the Fed provides liquidity and restores confidence in banking, inflation fears will resurrect the “higher for longer” policy. As we saw last year, such policy accompanied higher bond yields and lower stock prices.

If the Fed is not supportive enough of the banking sector with lower rates and liquidity, the banking crisis can quickly get out of hand. A waterfall in stock prices and much lower bond yields can quickly occur if they lose control of the crisis narrative.

Of course, there is a probability the Fed threads the needle and tackles inflation while avoiding deepening the banking crisis. Even in that preferred case, the economy must still grapple with tighter financial standards resulting from the banking crisis. A recession, lower corporate earnings, and weaker stock prices are likely in that situation. Bond yields will likely decline in an economic downturn as inflationary pressures lessen.

Stocks may rally in the coming weeks or months as it appears the banking crisis is over, and the Fed is set to pause and pivot. We offer caution; this may be the calm before the recession.

Following your trading rules will prove very important as the year progresses.

The Silent Bank Run

Long before Silicon Valley Bank failed, the banking sector was experiencing a silent bank run. Unlike the Great Depression, where lines of people clamoring for their money were blocks long, this silent bank run, as its name portends, has been out of sight until recently. There are a couple of reasons for this. First, online banking allows for split-second transfers from one bank to another bank or financial institution. Second, unlike the Depression, this silent bank run has been gradual and lacks media coverage.

Until the last week, the silent bank run has not been about solvency concerns such as the Depression. Instead, customers moved money from banks to higher-yielding options outside the banking sector. The graph below from Pictet Asset Management shows that money market assets and domestic bank deposits have trended in opposite directions since the Fed started hiking interest rates. As a result of the silent bank run, banks must tighten lending standards and sell assets. This is already happening. To wit: “The primary loan market feels like a Scooby Doo ghost town – recently deserted and a bit haunted.” – Scott Macklin -AllianceBernstein. Because the economy heavily depends on increasing amounts of credit to grow, this silent bank run will likely lead to a recession.

bank deposits money market assets

What To Watch Today





Bull Market Is Back – Buy Signals Light Up

In early February, we recommended reducing exposure as all of the “sell signals” triggered.

“While that sell signal does NOT mean the market is about to crash, it does suggest that over the next couple of weeks to months, the market will likely consolidate or trade lower. Such is why we reduced our equity risk last week ahead of the Fed meeting.”

Of course, since then, the market did trade decently lower. However, with the rally yesterday as the “banking crisis” was laid to rest, the market not only confirmed the test of the December low support but rallied above key short-term resistance and triggered both our MACD and Money Flow “buy signals,” as shown.

The only challenge for the market between yesterday’s close and the February highs is the 50-DMA which is short-term resistance. The 200-DMA is now confirmed support. If the market breaks above the 50-DMA tomorrow, there is plenty of “fuel” for the market to push to 4200-4400.

Market trading update

Primary MoneyFlow Indicator Registers Buy Signal

Money Flow Indicator

We will be increasing exposure to portfolios fairly quickly, starting most likely tomorrow following the Fed announcement. The market is sniffing out a fairly dovish take from the Fed, so we will see if they are right.

Investor Conditioning vs. Reality

Lance Roberts leads his latest ARTICLE with a critical question.

“QE” or “Quantitative Easing” has been the bull’s “siren song” of the last decade, but will “Not QE” be the same?

Whether the latest bank bailout is technically QE or not, investors seem conditioned to believe that any Fed-related bailout is QE. If that holds this time, the latest jump in Fed assets, shown below, is probably bullish. In one week, the Fed offset over four months’ worth of QT. The second graph from the article shows the robust correlation between the growth of the Fed’s balance sheet and the growth of the S&P 500. While the economic outlook may not be good, liquidity or perceived liquidity can drive markets higher for extended periods.

Fed balance sheet
investor conditioning

Insuring All Deposits

The Fed and Treasury are contemplating guaranteeing the banking system’s $17.6 trillion of deposits. The problem is the FDIC only has $128b of capital. While insuring deposits may make sense, banks must raise capital to build the proper amount of FDIC insurance to cover all deposits. If the Treasury decides to insure deposits, will they issue trillions of debt to create a backstop? Or might they rely on funding from the market when the insurance is needed? Whether it’s larger deficit funding or capital funding from banks, the effects are concerning.

commercial bank deposits

High Two-Year Note Volatility May Stick Around

As shown below, the two-year note recently fell by about one percent over the last few weeks. A crisis of sorts accompanied each prior significant decline. If you notice, the large declines tend not to be one-time moves. Volatility tends to stick around. Thus, the recent decline is likely not the last big move up or down. Rate volatility may be here to stay for a while.

2 year note volatility

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“Not QE” Puts Fed Between A “Rock And A Hard Place”

“QE” or “Quantitative Easing” has been the bull’s “siren song” of the last decade, but will “Not QE” be the same?

Last week, amid a rash of bank insolvencies, government agencies took action to stem a potential banking crisis. The FDIC, the Treasury, and the Fed issued a Bank Term Lending Program with a $25 billion loan backstop to protect uninsured depositors from the Silicon Valley Bank failure. An orchestrated $30 billion uninsured deposit by eleven major banks into First Republic Bank followed. I suggest those deposits would not occur without Federal Reserve and Treasury assurances.

The details of the Bank Term Funding Program (BTFP) were described in the press release by the Federal Reserve. To wit:

“The additional funding will be made available through the creation of a new Bank Term Funding Program (BTFP), offering loans of up to one year in length to banks, savings associations, credit unions, and other eligible depository institutions pledging U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. These assets will be valued at par. The BTFP will be an additional source of liquidity against high-quality securities, eliminating an institution’s need to quickly sell those securities in times of stress.

With approval of the Treasury Secretary, the Department of the Treasury will make available up to $25 billion from the Exchange Stabilization Fund as a backstop for the BTFP. The Federal Reserve does not anticipate that it will be necessary to draw on these backstop funds.”

Banks quickly tapped the program, as shown by the $152 billion surge in borrowings from the Federal Reserve. It is the most significant borrowing in one week since the depths of the Financial Crisis.

Total Borrowing From Fed Discount Window

The importance of this program is that, as noted by Bloomberg, it will inject up to $2 Trillion into the financial system.

“‘The usage of the Fed’s Bank Term Funding Program is likely to be big,’ strategists led by Nikolaos Panigirtzoglou in London wrote in a client note Wednesday. While the largest banks are unlikely to tap the program, the maximum usage envisaged for the facility is close to $2 trillion, which is the par amount of bonds held by US banks outside the five biggest, they said.”

As Bloomberg notes, major banks like JP Morgan likely will not tap the Feds lending program due to the stigma often attached to such usage. Moreover, there are roughly $3 Trillion in reserves in the U.S. banking system, of which the top-5 major banks hold a significant portion. However, as I noted last week in “Bank Runs:”

“The Fed caused this problem by aggressively hiking rates which dropped collateral values. Such has left some banks which didn’t hedge their loan/bond portfolios with insufficient collateral to cover the deposits during a ‘bank run.'”

As shown, the rapid increase in rates by the Fed drained bank reserves.

Fed funds vs reserve balances

The demand by banks for liquidity has now put the Federal Reserve between a “rock and a hard place.” While the Fed remains adamant in its inflation fight, the BTFP may be the next “QE” program disguised as “Not QE.”

NFIB Signals, NFIB Signals A Recession Is Coming…Again

Investor Conditioning

Classical conditioning (also known as Pavlovian or respondent conditioning) refers to a learning procedure in which a potent stimulus (e.g., food) becomes paired with a previously neutral stimulus (e.g., a bell). Pavlov discovered that when he introduced the neutral stimulus, the dogs would begin to salivate in anticipation of the potent stimulus, even though it was not currently present. This learning process results from the psychological “pairing” of the stimuli.

This conditioning is what happened to investors over the last decade.

In 2010, then Fed Chairman Ben Bernanke introduced the “neutral stimulus” to the financial markets by adding a “third mandate” to the Fed’s responsibilities – the creation of the “wealth effect.”

“This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose, and long-term interest rates fell when investors began to anticipate this additional action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”

– Ben Bernanke, Washington Post Op-Ed, November, 2010.

Importantly, for conditioning to work, the “neutral stimulus,” when introduced, must get followed by the “potent stimulus” for the “pairing” to complete. For investors, as the Fed introduced each round of “Quantitative Easing,” the “neutral stimulus,” the stock market rose, the “potent stimulus.” 

As shown, asset prices rose as the Fed expanded its balance sheet.

Fed balance sheet vs stock market

While many suggest that the Fed’s QE programs have no impact on the financial market, the near 87% correlation between balance sheet changes and the market would imply otherwise.

Correlation between Fed balance sheet and the stock market

Such is why investors cling to each Fed meeting in anticipation of the “ringing of the bell.”

In Pavlovian terms, the “pairing is complete.”

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While the BTFP facility is technically “Not QE,” it does reverse the Fed’s efforts to reduce financial liquidity. As shown below, the Fed’s balance sheet surged since last week, reversing more than six months of previous tightening.

Fed Balance Sheet expansion

This reversal of liquidity is not surprising given the recent rout in the banking sector.

J.P. Morgan noted on Friday that U.S. banks lost nearly $550 billion in deposits last week. Investors, in a panic, were transferring funds to major banks from regional banks, which put further stress on already discounted collateral due to the Fed’s rate hiking campaign.

The big picture from the H.4.1 release is that the U.S. banking system induced the Fed to expand its balance sheet and inject $440bn of reserves in just one week. That large liquidity injection reverses a third of the previous $1.3tr of reserve tightening since the end of 2021. Given such a backdrop of elevated banking system liquidity or reserve needs, this naturally raises the question of whether the Fed can continue QT, similar to 2018/2019.

This is NOT QE, as no NEW money was created. The banks’ eligible assets collateralize these loans under the Discount Window facility. The Fed is not purchasing the collateral. Once the loans are repaid, the collateral gets returned to the banks, and the Fed’s balance sheet will shrink again.

However, as noted above, this is the “ringing of the bell” by the Fed. But more notably, as repeatedly discussed, it was only a matter of time before the Fed “broke something.”

The economy and the markets (due to the current momentum) can  DEFY the laws of financial gravity as interest rates rise. However, as interest rates increase, they act as a “brake” on economic activity. Such is because higher rates NEGATIVELY impact a highly levered economy.”

Fed interest rates and crisis events”

History is pretty clear about the outcome of rate hiking campaigns.

Over the weekend, the Fed opened “dollar swap lines” after the UBS/Credit Suisse takeover. Historically, once the Fed resorts to reopening dollar swap lines, the rest of the programs follow, from rate cuts to the “real” QE and other monetary supports.

NFIB Signals, NFIB Signals A Recession Is Coming…Again

The Fed Created This

As noted in this past weekend’s newsletter, the Fed must choose between fighting “inflation” or again bailing out the financial system in the name of “financial stability.”

Of course, this entire situation is entirely due to the Federal Reserve.

In October 2020, I wrote an article arguing that Neel Kashkari was wrong and the Fed was indeed creating a “moral hazard” by injecting massive stimulus into the economy following the pandemic. The literal definition of “moral hazard” is:

The lack of incentive to guard against risk where one is protected from its consequences, e.g., by insurance.

Unsurprisingly, zero interest rates, $5 trillion in fiscal policy to households, and $120 billion in monthly “QE” removed all “risk” from owning “risk assets.” The resultant spike in inflation and speculative risk-taking was the result.

However, the “lack of incentive to guard against risk” becomes problematic when monetary, fiscal, and zero-interest-rate policies are reversed.

Yes, this is all the Fed’s doing.

However, since the turn of the century, the Fed has been able to repeatedly support financial markets by dropping interest rates and providing monetary accommodation. Such was because inflation remained at low levels as deflationary pressures presided.

Fed balance sheet and infaltion

With inflation running at the highest levels since the 80s, the Fed risks creating another inflationary and interest rate spike if they focus on financial stability. However, if they focus on inflation and continue hiking rates, the risk of a further crack in financial stability increases.

I don’t know which path the Fed will choose, but there seems to be little upside to the markets. The “moral hazard” the Fed created in the first place has now come home to roost.

UBS Bank Bailout of Credit Suisse May Open Pandora’s Box

The Silicon Valley Bank failure, originally considered a one-off event, is escalating and spreading. On Sunday afternoon, UBS, with significant liquidity and financial backstops from the Switzerland National Bank (SNB), bought Credit Suisse (CS) for about a third of its most recent market cap. The purchase may settle markets, but it potentially opens pandora’s box to more problems. For starters, harken back to Bear Stearns (BS). On a Sunday night almost 15 years ago, JPM bought BS for $2, pennies on the dollar. Markets rallied as the banking crisis was thought to be contained. Only months later, that narrative fell apart. UBS bank may have bought time, but it is far from clear the problem is over. Might UBS bank also find itself in trouble?

Second and maybe more concerning, laws were changed, and bond rules were ignored to facilitate the takeover. In desperation, the Swiss government changed its laws so that CS equity holders will not have a vote in the UBS merger. Further troubling, CS will completely write off $17 Billion of AT1 (additional Tier 1, a.k.a. CoCo bonds) Bonds. But, shareholders still receive $3.2 Billion. According to law, equity holders are the lowest rung of corporate financial structures and are expected to take 100% losses before bonds lose a penny. Wiping out bonds before equity holders is unprecedented. European and Asian banks predominantly issue CoCo bonds. U.S. banks issue preferred shares instead of CoCo bonds. The Bloomberg graphic below shows that an Invesco AT1 ETF is trading down sharply.

coco bonds foreign

What To Watch Today


Economic Calendar


  • No notable earnings releases today.

Market Trading Update

As the Fed starts its two-day FOMC meeting, the markets continue to tread water in anticipation of the announcement on Wednesday.

Despite the negative news headlines, the market remains above its December lows and retook the broken 200-DMA from last week. If the market can hold above that level for the week, then the bulls may be able to regain control of the narrative short term. Importantly, our MACD “buy signal” is again very close to turning from a decently oversold condition. While it did fail the last attempt, a positive signal would confirm that price action is more bullish, and we will need to increase exposure accordingly.

There is no rush to make any additions today, we will wait to see what the Fed has to say tomorrow and how the market responds. However, the market remains in a well-defined consolidation range since last June, and a bullish breakout to the upside will confirm the end of the bear market.

Be careful being “overly bearish” due to headline risk, the market continues to suggest decent underlying strength, and with the 50-DMA above the 200-DMA, the easiest path for prices remains higher near-term.

Market trading update

What Are Central Bank Dollar Swaps?

The Fed announced they will offer daily currency swaps as part of the CS bailout. These swaps are essentially collateralized dollar loans to foreign central banks. From the Fed’s perspective, the loans stop central banks from having to sell U.S. Treasury securities to raise cash. They also provide central banks with needed dollar funding to pass on to their local banks. The bottom line- the Fed is indirectly helping or bailing out foreign banks. At the same time, they are making sure U.S. Treasuries do not get sold in mass and the dollar retains its value.

The graph below provides a history of the usage of the swap lines. Comparing what will occur to what occurred in 2020 and 2008 may guide us on the seriousness of foreign banking problems.

currency dollar swaps central  cs ubs lending

Are Domestic Banks a Buy?

This is a tricky question; unfortunately, there is no good answer. As we are seeing, banks with strong balance sheets are being forced to sell underwater assets to meet depositor demands. As this occurs, the banks need capital which further worries existing depositors. No matter how strong a bank’s balance sheet is, a bank run can bankrupt any bank, especially those with unrealized losses on their books, as all banks have now due to higher interest rates. Banks are historically cheap, but the unknowns are significant. The following quote comes from Vivek Juneja, a bank analyst from JP Morgan:

We expect large bank stocks to remain choppy near term but for medium term holders the sector looks attractive due to cheaper valuation and stable/growing deposits, albeit with some uncertainty surrounding potential regulatory fallout. Large bank stocks are down 5-25% since March 8 when Silicon Valley Bank’s issues unfolded – money centers are trading at 7.7x 2024 consensus EPS on average, well below 10.3x long-term average and regionals at 6.6x versus 11.4x long-term average.

The graph below compares the regional bank ETF, KRE, to the broader financial sector ETF (XLF).

small versus large financial institutions

Regional Bank Lending Matters

The economic aftershock from recent banking events will be problematic. The graphs below from Goldman Sachs show that small and medium-sized banks play a significant role in lending to many economic sectors. As all banks strengthen their balance sheet, they will tighten lending standards. It’s highly likely, that small banks will tighten more than large banks. As shown below, small and mid-size banks originate 80% of commercial real estate loans. Given the importance of real estate to the economy, we suspect this sector will soon find it much more challenging to re-finance existing maturing deals. Further, new funding demands will become tougher to attain and weigh on construction spending and related employment. This helps partially explain why the REIT sector is falling with the financial sector.

small financial institution lending and dollar swaps

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Bear Stearns’s Failure Was 15-Years Ago This Month

Bear Stearns’s failure occurred 15 years ago last week. Six months later, Lehman Brothers would fail on September 15, 2008.

Fast forward to the present day, and we recently had the largest bank failure since 2008 when Silicon Valley Bank failed on March 10, 2023.

We will explore some interesting parallels between 2008 and 2023 in the next couple of paragraphs.

On October 11, 2007, the S&P 500 set an intra-day all-time high of 1,576.09. The day after the Bear Stearns failure (Bear Stearns failure was announced on a Sunday), the S&P 500 traded at an intra-day low of 1,257.98, thus creating a decline of -20.25% (see chart below).

Stock market 2008

On January 4, 2022, the S&P 500 set an intra-day all-time high of 4,818.62. On March 10, 2023 (the day of Silicon Valley Bank’s failure), the S&P 500 recorded an intra-day low of 3,846.32, thus creating a decline of -20.18%. As you can see below, the path was slightly different, but the result was the same.

Stock market current

The KBW Bank Index (ticker BKX) is designed to track the performance of the leading publically-traded banks and thrifts in the U.S. On February 2, 2007, BKX traded at an intra-day all-time high of 121.16. Then, on March 17, 2008, the day after the Bear Stearns failure, BKX traded at an intra-day low of 76.08, thus creating a decline of -39.57% (see chart below).

KBW Stock index 2008

On January 13, 2022, BKX traded at an intra-day all-time high of 148.96. On March 10, 2023, BKX traded at an intra-day low of 89.37, thus creating a decline of -40.01% (see chart below). While not the same, this is incredibly similar to the 2008 episode.

KBW Stock index current
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What Happened Next In 2008?

Over the next 63 days, the S&P 500 would appreciate 14.58% (intra-day low to intra-day high). That was followed by a 291-day period where the S&P 500 fell by -53.70% (intra-day high to intra-day low).

Stock market 2008

If we look at BKX directly after the failure of Bear Stearns, we find that in the four days following, BKX rallied 22.29%. However, over the next 347 days, BKX would decline by -80.18%.

BKW Index 2008-2009

Lastly, it’s worth noting where we were in the rate hiking cycle when Bear Stearns failed.

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The Housing Debacle

During The Housing Market Boom, the FOMC methodically hiked rates from June 2004 to June 2006 to a terminal rate of 5.25%.

Fed rate hike cycle 2004-2006

The FOMC remained on hold until September 2007, when they cut rates by 50 basis points. They would continue to cut rates through the remainder of The Housing Market Crash and The Great Recession (see below).

Fed rate hike cycle 2007-2008
Fed rate cuts 2008

The chart below shows the Fed Funds Effective Rate during the 2008 era and continuing on to the present day.

Fed funds effective rate 201-Present
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A Few Things To Note

First, there’s a lot of talk about the lag time that rate hikes have before they impact the economy. Most will handicap this by suggesting that rate hikes typically take 6 – 12 months to filter through the economy.

Bear Stearns’s failure occurred almost 21 months after the FOMC stopped raising rates. This would suggest that while the lag effect may take 9 months (average of 6 – 12 months) to kick in, the effects can be felt long after that.

Second, Bear Stearns’s failure and Lehman Brothers occurred well after the FOMC started cuttings rates. There is a large contingency out there that believes that everything will be fine once the FOMC starts cutting rates. Remember, if everything is okay, the FOMC has no reason to cut rates. They will only begin to cut rates once something is already broken.

The FOMC has its next meeting on March 21-22. There have been cries for them to pause their rate hiking campaign and reassess things in light of the recent bank failures. As of today, Fed Funds Futures are still pricing in a 25 basis point hike at next week’s meeting. With every rate hike, we continue to extend the period by which said rate hikes may negatively impact the economy.

Fed funds futures

In conclusion, the market has rallied this week largely on the heels of the Silicon Valley Bank situation not spiraling out of control. History would suggest that this rally could continue for several weeks, if not a month or two.

Don’t forget what happened in 2008 after the initial snapback rally. In my opinion, there will be additional bank failures or other areas of the market that “break,” it is inevitable. The question is when, how big, and how quickly it can be ring-fenced. Only time will tell.

Until then, the prudent bet is to err on being defensive. In a subsequent post, I will address how to know when to get back into the market and ratchet up your aggressiveness.

Expect the Fed to Follow ECB’s Lead This Week

The FOMC will announce its Fed Fund’s rate policy decision this Wednesday. Given the recent events in the banking sector, we return to the question posed Friday in Fed Mandates or Financial Stability: Will the Fed aggravate inflation by ignoring its Fed mandate and focusing on financial instability? The ECB’s rate decision last Thursday provides insight into what we can expect the Fed to do later this week.

Christine Lagarde announced a 50bps rate hike while reiterating the ECB’s focus on taming inflation. However, she also noted that the central bank closely monitors conditions and will step in with liquidity if necessary.

“The Governing Council is monitoring current market tensions closely and stands ready to respond as necessary to preserve price stability and financial stability in the euro area.”

Lagarde implied that the ECB doesn’t have to ditch its commitment to bring down inflation in favor of maintaining financial stability. It can focus on both simultaneously. Given the congressional mandate in the US, we expect the Fed to adopt a similar tone on Wednesday.

It certainly appears that financial cracks are showing as over the weekend, ailing 167-year-old Credit Suisse will now see itself into a forced marriage with stronger rival UBS. Furthermore, the Federal Reserve announced “coordinated” daily US Dollar swap lines to provide bank liquidity to ease financial stress with other banks.

Of course, this is just the first step that Federal Reserve takes in reversing monetary tightening. Historically, once the Fed takes this action, the next steps are rate cuts, QE, and other monetary supports. While the bulls may think the monetary policy reversal will be bullish for equities, history suggests the initial pivot will not be.

FRA-OIS spread chart

What To Watch Today


  • There are no notable releases today


  • There are no notable releases today

Market Trading Update

The market took out the support at the rising trend line and the 200-DMA, which violated our stop-loss levels, where we reduced exposure to equities. With all of the previous bullish support levels broken, the next logical level of support is the December lows. A failure there will then set supports at the June and October lows.

The failed retest of the 200-DMA to close the week is not a good look. However, with markets fairly oversold, a rally attempt early next week before the Fed meeting won’t be a surprise. Hopes of a “pivot” due to financial stress could contribute to some buying pressure. However, any rally will be limited due to the 20- and 50-DMA just above Thursday’s rally peak.

Market Trading Update

One important point I discussed in Before The Bell is the importance of perspective.

Take A Step Back

While there are many headlines of “doom, gloom, and disaster,” a step back from the noise reveals a much different picture. As investors, one of the mistakes we make is viewing our portfolios on a year-to-date basis.

Wall Street designed this terrible practice to keep you upset so you will move money around the markets. Money in motion creates fees for Wall Street and generally losses for you.

Yes, the market has been challenging over the last 15 months. However, for most, we have been invested in the markets for longer. Therefore, step back and look at your portfolio over the last 3- or 4-years. Once you do that, a much different picture emerges, as shown. For example, if we look at the period from the March 2020 peak to the present, we find our portfolios are still higher by 24%. That roughly equates to an 8% annualized return which is exactly what would expect from the market.

Market Update 2

With 24/7 media looking for anything to make a headline out of, not to mention a bunch of commentators looking for clicks and views, try and focus on what matters to your investment goals.

Removing some of the emotions from our investment strategies can help us reach our long-term goals.

The Week Ahead

This week will be relatively quiet except for the Fed meeting on Wednesday and the durable goods order on Friday. We expect the Fed to increase the Fed Funds rate by 25bps at 2 pm ET on Wednesday. Jerome Powell will likely maintain his stance on bringing down inflation during the FOMC press conference at 2:30. However, we expect him to stress that the Fed aims to maintain flexibility and will be there to provide liquidity should financial instability arise.

We will receive data for February Durable Goods Orders and the S&P Global PMI Flash for March on Friday. While Durable Goods Orders data are received on a lag, the Flash PMI survey should provide better insight into how broad manufacturing activity is evolving.

Consumer Sentiment Takes a Breather

On Friday, the University of Michigan’s Consumer Sentiment indicator dipped lower for the first time in four months to 63.4 in March from 67 in February. Notably, according to the survey director, about 85% of the surveys had been conducted before the SVB failure. Thus, recent volatility in the banking sector was not a significant factor in the results. The current conditions and consumer expectations components fell, and year-ahead inflation expectations declined to 3.8% in March from 4.1% in February.

Consumer Sentiment

Squashing Misconceptions

The following chart made its rounds over the weekend. Some financial pundits claim this signals the end of QT, and QE has returned. This is not the case, however. The Fed’s balance sheet increased last week due to financial institutions borrowing from its Discount Window lending facility to meet withdrawals. Ayesha Tariq wrote a nice explainer:

“There are perhaps misconceptions surrounding the issue of the banks borrowing at the Discount Window but, the most important thing to remember is that no new money is being created. Hence, this is not QE, this is not bullish and this is just a temporary fix.

Since, no new money is being created this is actually not going to be inflationary either. This is just depositors getting their money back in a timely manner.

If anything, this gives the Fed the stability and ability to keep tightening without causing a full-blown banking crisis. But, even this is temporary.”

No new money is created because these are loans under the Discount Window facility, which are collateralized by the banks’ eligible assets. The Fed is not purchasing the collateral. Once the loans are repaid, the collateral gets returned to the banks, and the Fed’s balance sheet will shrink again. This is just a way for banks needing liquidity to meet withdrawals without creating a fire sale in the financial markets- not a return to QE. Treasuries and MBS continue rolling off the Fed’s balance sheet for now.

QE Misconceptions

Is the MOVE Index Flashing a Warning Signal?

The MOVE index measures the month-ahead implied volatility in Treasury yield volatility. It’s akin to a VIX for the fixed-income market, which has been surging recently. The chart below, courtesy of Jim Bianco, shows the MOVE index approaching levels last seen during the financial crisis. Essentially, the fixed-income market is pricing increasing uncertainty as short-term yields have begun plunging. The surge in the MOVE index alongside a rising VIX could signal that trouble lies ahead.

MOVE Index

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Fed Mandates or Financial Stability

Heading into next week’s FOMC meeting, the Fed’s big dilemna is whether to address recent financial instability or adhere to their Fed mandates. Per the San Francisco Fed: “Congress has given the Fed two coequal goals for monetary policy: first, maximum employment; and, second, stable prices, meaning low, stable inflation.” The Fed’s mandates argue the Fed should continue to focus on inflation. The unemployment is at historic lows which some at the Fed argue is too low. Prices, on the other hand are far from low and stable. Economic activity, which significantly affects employment and prices, is robust. The Atlanta Fed estimates 3+% GDP growth for the first quarter.

Based on the Fed mandates, the Fed should remain aggressive toward fighting inflation. Jerome Powell told Congress as much a week ago. Then came Silicon Valley Bank and Credit Suisse. The Fed has a self-created third mandate, financial stability. Financial stability often trumps the Congressional mandates. Investors are pricing in a 25bps rate hike, down from 50bps a week ago. More importantly, the markets imply Fed Funds will end the year at 3.75-4.00%. Quite the decline from 5.50-5.75%! Will the Fed aggravate inflation by ignoring its Fed mandate and focus on financial instability?

atlanta fed gdpnow

What To Watch Today


Economic calendar


  • No notable earnings reports

Market Regains Broken Support – Bulls Maintain Control

As I noted several times over the last few days, the broken support of the 200-DMA was important. However, a break of support needs to confirm itself by staying below that support for a trading week. Yesterday, the market rallied on news of more bank bailouts that pushed the money back into the market. The rally, led by Technology stocks, cleared the 200-DMA putting the bulls back in control of the market narrative.

Market Trading Update

However, while reclaiming the 200-DMA is important, the market now faces several more challenges ahead with the broken bullish trend line, the 20-DMA, and the 50-DMA all between current levels and 4000 on the index. Those resistance levels will likely limit the upside in the market ahead of the FOMC meeting next Wednesday.

If the market clears 4000, you can increase equity allocations accordingly. If not, we may be looking at another leg lower short term. Remain cautious for now and pick your spots to increase risk cautiously.

Time for Gold?

As noted in the opening, the market expects the Fed to cut rates aggressively later this year. As the market rapidly repriced Fed Fund expectations, gold rose sharply. Gold rose over $100 per ounce in just the last week. Gold is not necessarily soaring because of banking problems. The graph below from Ole Hansen of Saxo Bank shows that gold tends to have strong rallies when the Fed lowers interest rates. Gold investors are betting on an easy Fed. We also wrote about this phenomenon in Gold Investors Are Betting on the Fed. To wit:

The bottom line, gold prices are highly correlated with real yields when real yields are near or below zero. The correlation is negative, meaning that as real yields fall, gold prices rise. Said differently, gold prices increase when the Fed enacts a monetary policy that is too stimulative given the circumstances.

If the market is correct and the Fed is close to starting an easing campaign, gold may be in the early innings of a rally. However, gold can easily give up recent gains if fighting inflation remains goal number one. Longer term, the odds of a recession are high, in our opinion. Therefore a gold rally and decline in Fed Funds is likely, but it may not start yet.

fed funds and gold

Bear Stearns and the Pandemic; This Day in History

On March 16, 2020, exactly three years ago, the S&P 500 fell from 2711 to 2386, a 12% decline. While not as significant in percentage terms as 1987, it was the largest daily point decline. That happened a day after the Fed held an emergency meeting, cutting rates from 1.25% to 0%. They also enacted a massive $700 billion QE program and cut reserve requirements for banks to zero.

The market’s reaction was fearful despite the unprecedented Fed response. The market would sputter around for another week or two before a massive surge lasting the remainder of 2020 and 2021.

Also, on this day in 2008, JPM bought failing Bear Stearns for $2 per share. As a result of financial instability, the Fed cut rates from 3% to zero by the end of 2008. The stock market seemed to ignore the failure of a Wall Street powerhouse and instead focus on the bailout and Fed reaction. The S&P 500 would rally over 15% in the next two months, only to be cut in half in the next ten months.

We remind you of both events, not because they occurred on this day, but because they show the initial market reaction to Fed action can be wrong. Prudence is advised.

jpm buys bear stearns this day in history

New York and Philadelphia Point to a Recession

The New York Empire and Philadelphia Manufacturing Surveys were much weaker than expected. These regional surveys of business leaders tend to be good leading economic indicators.

The Empire index fell to -24.6 versus expectations of -7.7. There are two subcomponents in the report worth discussing. Per the Empire report:

The new orders index fell fourteen points to -21.7, indicating that orders declined substantially, and the shipments index fell fourteen points to -13.4, pointing to a decline in shipments.

New Orders are one of the best leading economic indicators. Currently, the broad ISM New Orders index is at levels on par with prior recessions. The Empire survey confirms that warning. The second concerning signal is in the chart below. While unemployment sits near 50-year lows and initial jobless claims are equally strong, the average employee workweek is declining. Often, companies will cut back on hours before firing employees. This may indicate that the labor market is about to weaken.

new york empire average workweek

The Philadelphia Fed was also weaker than expected at -23.2 vs. -15.5. Prices paid and received are still above zero, but the percentage responding that they see higher prices are falling quickly. Like the Empire report, new orders fell sharply, from -13.6 to -28.2. The number of employees and average workweek declined into negative territory.

The problem with both surveys is they do not reflect the recent banking crisis. Recent events will likely make them more negative on their immediate economic prospects.

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Consensus View Of “No Recession.” Could It Be Wrong?

Could the consensus view of a “no recession” scenario be wrong? As portfolio managers, this is the question we ask ourselves daily. Since the lows of last October, the technical backdrop has improved markedly, as discussed last week in “Bear Trap.” To wit:

“Our most critical bullish signals are the short- and intermediate-term Moving Average Convergence Divergence (MACD) indicators. We post this weekly chart in our website’s 401k plan management section. Both sets of weekly MACD indicators have registered buy signals from levels lower than during the financial crisis. The market has also broken above both weekly moving averages and, as noted above, held the long-term bullish trend line.”

Weekly technical analysis of the market.

While the technical backdrop continues to confirm and reaffirm a bullish trend supporting the “no recession” scenario, there remain substantial risks to that view. Such risks, as was seen with Silicon Valley Financial (SVB) last week, can arise quickly, turning previously bullish sentiment quickly bearish.

What happened with SVB is a result of tighter monetary policy extracting liquidity from the banking system. In an upcoming article, I quoted Thorsten Polleit from The Mises Institute, stating:

What is happening is that the Fed is pulling central bank money out of the system. It does this in two ways. The first is not reinvesting the payments it receives into its bond portfolio. The second is by resorting to reverse repo operations, in which it offers “eligible counterparties” (those few privileged to do business with the Fed) the ability to park their cash with the Fed overnight and pay them an interest rate close to the federal funds rate.”

As shown, contractions in nominal M2 have coincided with financial and market-related events in the past. Such is because the Fed is draining liquidity out of the financial system, which is a problem for overleveraged banks.

However, while SVB might be an isolated event, of which we are not sure, the driver of higher asset prices remains a consensus view that earnings will bottom in the second quarter of this year and begin to improve into year-end. If such is the case, given that markets lead fundamental changes, the market’s rally since last October is logical.

But that is the key to the markets this year. Is the consensus view right or wrong?

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Will Earnings Bottom?

The chart below shows the GAAP estimates (red dotted line) by S&P Global through the end of 2023. Amazingly, they expect earnings to recover to where they were at the bull market’s peak in 2022. Such was when interest rates were zero, and the Federal Reserve provided $120 billion monthly in “quantitative easing.”

S&P 500 earnings vs estimates

However, this view from S&P Global is the same as most Wall Street banks who expect the Fed to “pause” its rate hiking campaign and the economy to avoid a recession. That broad consensus view of a “no landing” scenario has fueled the market’s advance since January but remains at odds with much of the macroeconomic data.

As I discussed in “No Landing Scenario At Odds With Fed’s Goals,”

“Given the recent spate of economic data from the strong jobs report in January, a 0.5% increase in inflation and a solid retail sales report continue to give the Fed no reason to pause anytime soon. The current base case is that the Fed moves another 0.75%, with the terminal rate at 5.25%.”

That type of rhetoric doesn’t suggest a “no landing” scenario, nor does it mean the Fed will be cutting rates soon. Notably, the only reason for rate cuts is a recession or financial event that requires monetary policy to offset rising risks. This is shown in the chart below, where rate reductions occur as a recession sets in.

No Landing, “No Landing” Scenario At Odds With Fed’s Goals vs GDP

The problem with that data is that the lag effect of monetary tightening has not been reflected as of yet. Over the next several months, the data will begin to fully reflect the impact of higher interest rates on a debt-laden economy. However, as shown, while the consensus view is that earnings will grow strongly into year-end, higher rates drag on earnings as economic growth slows.

S&P 500 earnings vs estimates vs Fed funds

Of course, such is logical, given that earnings are derived from economic activity. As such, there is a decent correlation between economic growth and GAAP earnings.

GAAP earnings vs GDP growth

With the Fed continuing to hike rates, the ability of the economy to start expanding to support earnings growth seems questionable.

However, two other factors also suggest the consensus view is worth questioning.

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To Pivot Or Not To Pivot

The problem with the consensus view is that it requires the Fed to revert to monetary accommodation. However, if the consensus view is correct, why would the Fed change policy? As we noted previously:

  1. If the market advance continues and the economy avoids recession, the Fed does not need to reduce rates.
  2. More importantly, there is also no reason for the Fed to stop reducing liquidity via its balance sheet.
  3. Also, a “no-landing” scenario gives Congress no reason to provide fiscal support providing no boost to the money supply.

See the problem with this idea of a “no landing” scenario?

“No landing does not make any sense because it essentially means the economy continues to expand, and it’s part of an ongoing business cycle, and it’s not an event. It’s just ongoing growth. Doesn’t that entail that the Fed will have to raise rates more, and doesn’t that increase the risk of a hard landing?” – Chief Economist Gregory Daco, EY

As I noted, there are two additional problems with the consensus view of a sharp recovery in earnings.

The first is the reversal of the massive stimulus injections into the economy in 2020-2021, which provided for the surge in economic activity and earnings. As shown, money supply growth is reversing, with earnings also slowing. The consensus view expects earnings to buck that correlation in the future.

S&P 500 earnings vs estimates vs money supply growth

The second problem is inflation. During the pandemic shutdown, the massive supply of monetary stimulus collided with an economic shutdown leading to surging prices. Due to a lack of supply and a massive contraction in employment, surging prices sent corporate profit margins soaring. However, sustaining record margins will be challenging with inflation falling, the economy at full employment, and wages rising.

S&P 500 earnings vs estimates vs inflation.

While the markets are certainly betting on an optimistic scenario, logic suggests many challenges lie ahead.

There is still a lot of money sloshing around the economy from the repeated rounds of stimulus. Also, from the infrastructure spending bill, and increased social security and welfare benefits. The impact of higher rates on economic activity may get delayed but not eliminated.

As Jerome Powell noted in last week’s Senate Finance Committee testimony:

Inflation has moderated somewhat since the middle of last year but remains well above the FOMC’s longer-run objective of 2 percent… That said, there is little sign of disinflation thus far in the category of core services, excluding housing, which accounts for more than half of core consumer expenditures.

If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes… The historical record cautions strongly against prematurely loosening policy. We will stay the course until the job is done.

That certainly doesn’t suggest a pivot is coming any time soon. This brings us to the one question every investor must answer.

How does the consensus view come to fruition with higher interest rates, less monetary liquidity, and slower economic growth?

I don’t know the answer. However, I am not liking the odds that the outcome will be as positive as Wall Street expects.

Credit Suisse Bank is Next on the Docket

Shares of Credit Suisse and other large European banks traded sharply lower yesterday. This occurs only a few days after European leaders expressed little concern that U.S. banking problems would spread across the Atlantic. Credit Suisse Bank, down nearly 25% yesterday, appears to be the culprit. Credit Suisse, a foreign bank domiciled in Switzerland, has been on the ropes for a while. The graph below shows Credit Suisse has been in perpetual decline since 2008. Making matters for the bank worse yesterday, their largest investor, the Saudi National Bank, said they would not provide any more capital.

As noted in recent commentaries and articles, banking is based on a fractional reserve system. Consequently, there are more bank deposits than cash in the system. Such a system works well, but any bank, no matter how well capitalized, is mortally susceptible to a rapid drain of deposits. Fears of bankruptcy, capital raising, increased bond yields, and a sinking stock are triggers that set off depositors. As we saw with SVB and Signature bank, a surge in withdrawals can make a bad situation much worse. The following large European banks are following Credit Suisse bank lower: BNP Paribas, Deutsche Bank, UBS, Societe General, and Banco Santander, to name a few.

credit suisse bank

What To Watch Today


Economic data for Thursday



Market Trading Update

The market sold off again on Wednesday as Credit Suisse hit the headlines. However, by mid-afternoon, a plan emerged to save the troubled bank that is systemically important to the entire financial food chain. While the market cut its losses in half by the close, the failed test of the previous 200-DMA is now concerning. The market is oversold enough for a rally, so stocks could get a bid if we can get a day without a bank crisis unfolding.

With that said, we continue to suggest using rallies to reduce risk and rebalance portfolios for now. We raised cash further in portfolios yesterday and will likely add more to our bond holdings on any bond price pullback. Until the bulls regain control of the narrative, the risk remains elevated.

Money Flow Index

PPI and Retail Sales

PPI provided welcome news on the inflation front. The monthly change fell by 0.1% versus expectations for a 0.3% increase. Further, the prior month was revised from +0.7% to +0.3%. While the Fed will undoubtedly like the data, they continue to hang onto prices in the service sector, excluding housing, as their primary inflation gauge. As we share below from Charlie Bilello, PPI continues progressing toward more normal levels.

ppi inflation

Retail Sales fell by 0.4% but keep in mind that last month they rose a shocking 3.2%. Excluding vehicles and gas, both volatile sectors, sales were flat. The consensus was for a 0.9% decline. The graph below from Charlie Bilello shows that nominal annual retail sales growth is 4.03%, below the historical average of 4.79%. Further, inflation-adjusted retail sales remain almost 4% below the average.

retail sales

Yield Curve Recession Warnings are Strengthening

The graph below shows that yield curve inversions are an excellent leading recession warning. However, recessions do not start until yield curves un-invert. Before the SVB banking crisis, yield curves were inverting to 40-year lows. The U.S. banking crisis, spreading to Credit Suisse Bank and other large European banks, rapidly steepened the 2yr/10yr yield curve. While hard to see below, the 2yr/10-year yield curve has un-inverted by over 40bps in the last week. Despite two-year yields falling rapidly, 3-month yields remain steady. The market is pricing in aggressive Fed easing later this year but not in the next few months. The 2/10yr curve will often steepen before the 3m/10yr curve.

The recession warning is growing louder, but until the very short maturity yields start falling, it’s too early to have 100% confidence a recession is imminent.

yield curves and recessions

The Aftershock- Tighter Lending Standards

ZeroHedge shared the following quote from UBS:

After such a long period of catastrophically negative real wages, US consumers have used credit card borrowing to maintain living standards. Higher interest rates do little to deter this borrowing. Tighter lending standards stop it abruptly.

Our latest article Aftershock discusses how the SVB crisis will cause a significant tightening of bank lending standards. In the article, we share the graph below and write the following:

Financial lending standards quantify how easy or hard it is to attain a loan. The Federal Reserve graph below shows that the number of banks tightening lending standards for various loan types is increasing. The percentage of banks with tighter standards is on par with typical recession periods. The data for the graph was taken before the Silicon Valley Bank was on anyone’s radar. We suspect the percentages will proliferate as the aftershocks of the crisis are felt.

tighter lending standards

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Rate Pivot or Higher For Longer

Less than a week after Jerome Powell was pounding the table on Capitol Hill, arguing the Fed must stay aggressive in its inflation fight, the market thinks the Fed is about to make an abrupt pivot and drop the Fed Funds rate rapidly. The graph below compares expectations for Fed Funds on March 7 (light blue) and today (dark blue). Remarkably, Fed Funds futures imply a pivot, with rates ending the year about 1.25% lower than expected seven days ago.

Markets are trying to figure out what the Fed now thinks. Will they agree that the banking crisis was a warning shot and they must pivot to lower interest rates to ensure the problems don’t multiply? If they were to take such action, would that destroy all credibility they have earned regarding being steadfast against high inflation? Also, if investors grow concerned that the Fed will not fight inflation, will the dollar sink, gold and commodities rise, and long-term yields increase? There are a lot of crucial questions that need to be addressed. We hope our visibility into Fed priorities clears up between now and the 3/22 Fed meeting. Until then, prudence is likely the best course of action.

fed funds expectations

What To Watch Today


Economics calendar



Market Trading Update

With the bailout pulling some of the stress off the financial sector, the market’s oversold condition allowed for a rally yesterday. The rally failed at the 200-DMA, its first attempt to reclaim broken support. Such initial failed attempts happen often, but the market must retake that resistance by the end of this trading week. A weekly close below the 200-DMA will suggest bears have regained control of the market short term.

We continue to suggest taking profits and reducing equity risk unless, or until, the market regains a more bullish footing. With next week’s Fed meeting, traders will likely remain cautious, limiting the upside for now. Also, our MACD “sell signal” remains firmly intact, suggesting that risk is to the downside.

Market Trading Update

CPI on the Screws

CPI came in largely as expected, with the monthly rate climbing 0.4% and the year-over-year rate falling from 6.4% to 6.0%. The monthly core CPI was .10% more than expectations and last month’s reading. At 0.5%, core CPI is running at a 6.0% annualized rate and appears sticky at current levels. Further supporting the stickiness of inflation theory are core service prices, excluding housing. The Fed has signaled that this indicator is their preferred gauge to determine the stickiness of prices. As shown below, the so-called Supercore CPI has risen three months in a row and shows no signs of ebbing.

core cpi inflation

The Fed claims they are “data dependent” in its monetary policy moves. The CPI data, on its own, provide no reason for the Fed to back off its hawkish stance. As such, how will they balance data dependency with the banking crisis? Last week wrote Speak Loudly Because You Carry A Small Stick to discuss the Fed’s predicament. Per the article:

Given the lag effect of prior rate hikes and the massive leverage embedded in the economy, we advise Jerome Powell to speak very loudly but take limited further action regarding rate hikes.

Our concern was the damage higher rates would do and the lack of ability to foresee economic or financial problems. As such, we advise the Fed to take it easy on rate hikes but be as hawkish as possible. Furthermore, with the new bank crisis, our advice is more important. At next week’s FOMC meeting, we expect the Fed to issue a strongly worded warning about the need to get inflation back to its target of 2%. At the same time, they may bring up pausing, so they don’t worsen the banking crisis. The situation is fluid, but as of today, we suspect they will increase by 25bps next week but emphasize flexibility.

Bank Runs

Seemingly out of nowhere, bank runs took down the nation’s 18th-largest bank and several smaller regional banks. Bank runs, even for the soundest bank, are always a risk. The simple fact is that banks run a Ponzi scheme of sorts. Lance Roberts explains why in his latest article- Bank Runs. The First Sign The Fed “Broke Something.” Per Lance:

“Bank runs” are problematic in today’s financial system due to fractional reserve banking. Under this system, only a fraction of a bank’s deposits must be available for withdrawal. In this system, banks only keep a specific amount of cash on hand and create loans from deposits it receives.

The problem facing banks is not one of trust, as is typical of a bank run. Instead, it’s customers can earn more yield elsewhere. Total banking deposits fell annually for the first time since 1948. Depositors are shifting money to money market funds and Treasury Bills to capture 4+% interest rates. This is just one of the unintended consequences of the Fed not tightening monetary in 2021 when the seeds of inflation were sown. As a result of acting too late, they had to raise rates higher than they might have. The bank run, and likely other economic and financial problems, are and will be the consequences.

bank run on commercial bank deposits

Junk Bond Investors Finally See Risk

On February 24, 2023, and on a few other occasions, we wrote about low corporate bond market yields and our concern that poorer credit quality bond prices were not accurately reflecting enhanced risks. The February Commentary warned that corporate bond investors were “picking up pennies in front of a steam roller.” The graph below shows that the junk bond yield spreads versus U.S. Treasuries rose about 1% in the last few days. It appears a few investors hear the steamroller coming!

junk bond spreads

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Aftershock Life After Silicon Valley Bank

While headlines of bank failures and bailouts consume the media, few are contemplating the economic and financial aftershocks that will follow.

Hockey great Wayne Gretzky famously commented, “I skate to where the puck is going to be, not where it has been.” Let’s take his advice and consider where the economic puck will be tomorrow.

The Silent Bank Run

The banking sector was experiencing a silent bank run well before Silicon Valley Bank made the headlines.

Unlike the Great Depression, where lines of people clamoring for their money were blocks long, this bank run is quiet and calm. For starters, online banking makes moving money from one bank to another financial institution simple and instantaneous. Second, unlike the Depression, which happened suddenly, this bank run has been happening for a year.

Despite much higher interest rates, banks were not increasing interest rates for most of their depositors. Consequently, customers gradually moved money from banks to higher-yielding options outside the banking sector. This bank run is not necessarily about the risks of holding money at a bank, as it was in the Depression, but about the opportunity to earn higher yields elsewhere.

As we share below, commercial bank deposits are doing something they haven’t done since 1948. They are trending lower for an extended period.

bank deposits
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Bank Runs and Bank Balance Sheets

To better understand the economic implications of declining deposits and their potential aftershocks, it’s worth summarizing bank balance sheets.

Commercial bank liabilities, in the aggregate, as shown below, are primarily deposits. Deposits allow banks to lend money and therefore are the lifeline of the banking system.

bank liabilities

As the amount of bank deposits decline banks must commensurately shed assets. The following pie chart shows the assets commercial banks hold in the aggregate.

bank assets

Banks sell from the pies in the chart above to meet withdrawals. However, from an economic perspective, as we will explain, it’s not necessarily what they sell but to whom they do not lend to going forward.

Further, given the Fed’s new BTFP facility, banks are incented to hold on to Treasury and mortgage assets. As such, other asset types will be sold or, at a minimum, not added to. The other assets are loans which drive economic activity.

The Bank Reaction Function

So, how do banks gear up for the aftershock?

Banks can significantly increase deposit rates and hope to grow or at least not lose more deposits. However, doing so will reduce their profit margins and put further pressure on their stock prices. Most bank executives are paid dearly in stock. Therefore, we doubt many executives will support competitive deposit rates.

We think banks will sell assets and let existing assets mature without replacing them to match declining deposits. For such a leveraged economy, this will be a big aftershock.

Financial lending standards quantify how easy or hard it is to attain a loan. The Federal Reserve graph below shows that the number of banks tightening lending standards for various loan types is increasing. The percentage of banks with tighter standards is on par with typical recession periods. The data for the graph was taken before the Silicon Valley Bank was on anyone’s radar. We suspect the percentages will proliferate as the aftershocks of the crisis are felt.

tightening financial lending standards bank run

The spotlight on banks will force a more conservative stance. Consequently, they will lend less money and become choosier in who they lend to. This new objective will keep loans out of the hands of riskier companies and individuals. Reducing loans available throughout the system will also raise borrowing costs for needier borrowers.

Zombie Companies at Risk

The graph below shows there are about 600 zombie companies out of the approximate 3000 companies in the Russell 3000 small-cap index. One in five companies in the index does not produce enough profit to pay interest on their debt. They must continually borrow to remain a growing concern. Many of these and smaller mom-and-pop companies will either pay much higher interest rates for working capital or not get needed funding. In either case, higher unemployment and bankruptcies are sure to follow. 

zombie companies
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The Leverage Tax

In Speak Loudly Because You Carry A Small Stick, we share the graph below. The point was to highlight how dependent the economy has become on debt. To that end, economic growth has become conditional on easy borrowing conditions and low-interest rates.

debt to gdp leverage

While interest rates have fallen recently, they are still well above the levels of the last ten years and in time will add to what we call a leverage tax on the economy. As we wrote:

The process whereby higher interest rates slowly but increasingly weaken the economy is known as the lag effect.

In the aftershock of the banking crisis, tighter lending standards and higher interest rates will increase the leverage tax on the economy. Economic growth is sure to falter as a result. 

Fed Pivot?

The graph below shows that year-end Fed Funds expectations fell by over 1% in just the last week.

fed pivot

Are investors jumping to the conclusion that the Fed will pivot, or should they be concerned that the Fed will remain steadfast in its fight against inflation?

The possible silver lining from the Fed’s perspective is that the banks, via tighter lending standards and likely higher interest rates, will curb economic demand and therefore dampen inflationary pressures. Such a circumstance may keep the Fed from not increasing interest rates as much as they thought they might have to.

If banks significantly tighten standards, the Fed may be dealing with disinflationary pressures sooner than expected. Banks, not the Fed, create money as they make loans. If fewer loans are made, less money is created. Subsequently, the nation’s money supply will decline further.

Yes, we said, “further.” The year-over-year change in the money supply has declined for the first time since the Depression, as the re:venture consulting graph shows. Each previous decline was met with an economic depression or financial crisis.

money supply crisis

Barring a pickup in monetary velocity, a decline in the money supply is deflationary.

As we saw in this week’s CPI data, the flip side of the deflationary argument is that inflation remains sticky. The economy may brush the banking crisis aside for a while. Accordingly, the Fed may think they have the crisis ring-fenced. Such a mindset could enable the Fed to raise interest rates higher than the market believes. As we have written on many occasions, the economic and market impact of higher interest rates will lead to financial and economic difficulties down the road.

Both Fed paths are problematic!

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Consumer Sentiment

Consumers account for about 70% of economic activity. Banking crises hit home as the safety of our own money is at stake. As a result, consumers tend to tighten the reins on spending as banking crises are never welcome economic news.

Consumer confidence will likely decline from current levels, and consumption will follow. It may take a few weeks or even a month before consumer surveys, and economic data reflect the new mindset of the consumer. Stock market volatility will also weigh on consumer sentiment.

The Fed and many economists believe the stock market drives the economy. When people have more wealth, they tend to spend more so goes the Fed’s logic. Following similar logic, recent stock market volatility will likely dampen consumer confidence.


The banking earthquake is sending shockwaves through the financial markets. The financial and economic aftershocks, soon to follow, are underappreciated and may prove worse than the earthquake.

We have been warning that interest rate hikes take time to affect the economy fully, but in time, the Fed will break something. The combination of the lag effect of last year’s rate hikes and the recent crisis leads further credence to a hard landing scenario.

As we wrote in The No Landing Scenario and UFOs:

While the economy may seem unpredictable, the economic future is predictable. The no landing scenario assumes economic cycles have ceased to exist. The economic cycle is alive and well. But timing its ups and downs with unprecedented amounts of fiscal and monetary stimulus still flowing through the economy and markets is proving incredibly challenging. 

We believe timing the economic downs has just become a little less challenging!

BTFP The Latest Bank Bailout

On Sunday afternoon, the Fed and Treasury rode the rescue with the Bank Term Funding program, BTFP, the latest bank bailout. The government staring at potential bank runs shored up banks and helped comfort depositors that their money is safe. The facility will save some banks from selling underwater bonds and taking losses in order to free up cash for depositors. Consequently, participating banks can pledge eligible bonds to the BTFP facility and receive a one-year loan for the bond’s par value. The facility only applies to U.S. banks and bonds owned before the announcement. Some banks may be unable to take advantage of the program as they do not hold a measurable amount of Treasuries or MBS. The BTFP program will last for one year.

Now, our two cents and what this means from a macroeconomic perspective. For starters, the Fed may have more leeway to raise rates as most banks are protected against being forced to take losses and raise capital. Counter to the argument, lending standards will increase significantly, which will drag on economic activity and do the Fed’s heavy lifting. Further, tightening standards will put those companies most heavily reliant on bank funding at risk. Some believe BTFP opens the door for a Fed pivot. With the battle against high inflation still in progress we are not sold the Fed will give up the fight so early. We will learn a lot more about the program at next week’s FOMC meeting.


What To Watch Today





Market Trading Update

The market rebounded from the opening lows as the Fed launched a program allowing banks to provide discounted collateral for loans at full face value. This facility will allow banks the capital they need to meet depositors’ redemption requests. However, as discussed next, with more regional banks having trouble, the market rebound had trouble hanging on for the day.

The market is oversold but has broken all major supports of the previous bullish trend. Such puts us into “risk off” mode and suggests we use short-term rallies to reduce risk and rebalance portfolios. We have warned several times over the last year, that the aggressive rate hiking campaign would break something either in the economy or the credit market.

It appears the first cracks are in the credit market. Such is seen in the US sovereign credit risk based on 1Y CDS spreads, which have soared to a record high. This move eclipses what was seen during the Lehman event or the debt ceiling crisis.

Credit risk

Hold positions now as the market bounced off support from the December lows. However, use any reflexive rally that does NOT clear the 200-DMA as an opportunity to raise cash and reduce risk.

Market Trading Update

More Regional Banks on the Ropes

Despite the BTFP program, many regional bank stocks are still struggling. For instance, First Republic Bank (FRC) is down about 75% in just the last week. Joseph Wang, an ex-Fed employee, shows why the stock is sharply lower in Monday’s trading below. Most of FRC’s holdings are in municipal bonds. As of year-end, they held no Treasury securities and only a small amount of MBS or agency assets. As it is currently structured, BTFP will not help them avoid losses. We suspect investors are combing through bank balance sheets to figure out which banks can take advantage of the bailout. Some of those that can’t may join Silicon Valley Bank in receivership unless the Fed devises a new structure.

regional banks asset breakdown FRC

Two Year Yields Plummet

In just the last five days, the yield on 2-year Treasury notes has fallen nearly 1%. As the graph below shows, the last time it fell by as much in such a short period was 1988. The two-year yield is clearly pricing in a Fed pivot. Bond investors now assume that the Fed will prioritize the banking sector over inflation. If that proves true, the cessation of rate hikes, possibly after the March meeting, and a pivot are probable. That said, if the Fed thinks they have properly protected banks from more losses due to higher interest rates, the two-year yield may reverse recent gains.

two year yields plummet

Places to Hide in the Financial Sector

Within SimpleVisor we share our proprietary relative and absolute analysis on markets, sectors, factors, and stocks. The analysis uses 13 technical studies to assess which stocks are over or underperforming versus the market, its sector, or on a stand-alone basis. Today we share our analysis and dive into the financial sector and see which stocks are holding up well despite the turmoil.

The table below shows how the top ten holdings of XLF score relative to XLF. Our relative analysis uses technical analysis on the price ratio of each stock to XLF and assigns a score. The higher the score, the more overbought the stock is compared to XLF. Conversely, lower scores are those that are oversold. As shown, JPM is the most overbought bank in the financial sector. Bank of America (BAC) is the most oversold. Often highly overbought or oversold conditions normalize.

The second graphic is a relative comparison of JPM to BAC. Not surprisingly, the ratio is extremely overbought (in JPM’s favor). If you think the banking crisis is ebbing, you may want to dip your toes in the most underperforming stocks, like BAC. That said, there are many unknowns, and we advise prudence and, as such, staying away from banking stocks until the smoke clears a bit.

financial sector
financial stocks jpm bac

Tweet of the Day

fed financial crisis

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Bank Runs. The First Sign The Fed “Broke Something.”

With the collapse of Silicon Valley Bank, questions of potential “bank runs” spread among regional banks.

“Bank runs” are problematic in today’s financial system due to fractional reserve banking. Under this system, only a fraction of a bank’s deposits must be available for withdrawal. In this system, banks only keep a specific amount of cash on hand and create loans from deposits it receives.

Reserve banking is not problematic as long as everyone remains calm. As I noted in the “Stability Instability Paradox:”

The “stability/instability paradox” assumes that all players are rational and such rationality implies an avoidance of complete destruction. In other words, all players will act rationally, and no one will push “the big red button.

In this case, the “big red button” is a “bank run.”

Banks have a continual inflow of deposits which it then creates loans against. The bank monitors its assets, deposits, and liabilities closely to maintain solvency and meet Federal capital and reserve requirements. Banks have minimal risk of insolvency in a normal environment as there are always enough deposit flows to cover withdrawal requests.

However, in a “bank run,” many customers of a bank or other financial institution withdraw their deposits simultaneously over concerns about the bank’s solvency. As more people withdraw their funds, the probability of default increases, prompting a further withdrawal of deposits. Eventually, the bank’s reserves are insufficient to cover the withdrawals leading to failure.

However, as we warned in January 2022 (2 months before the first Fed rate hike.)

The rise and fall of stock prices have very little to do with the average American and their participation in the domestic economy. Interest rates are an entirely different matter.

And, as discussed in “Rates Do Matter,”

The economy and the markets (due to the current momentum) can  DEFY the laws of financial gravity as interest rates rise. However, as interest rates increase, they act as a “brake” on economic activity. Such is because higher rates NEGATIVELY impact a highly levered economy.”

Fed rate hikes and financial events.

History is pretty clear about the outcome of rate hiking campaigns.

Contact US

A $17 Trillion Problem

While higher rates increase consumer borrowing costs, they also negatively impact bank capital. As noted above, banks are fine until customers begin to withdraw funds.

What the Federal Reserve didn’t account for in hiking rates were two critical things.

  1. The negative impact on bank collateral (as interest rates rise, collateral values fall)
  2. At what point would customers liquidate demand deposits for higher-yielding assets?

These two points have a crucial relationship.

When banks take in customer deposits, they loan those funds to others or buy bonds. Since loans are longer-term assets, the bank cannot reclaim its funds until loan maturity. Therefore, there is a duration mismatch between the bank’s assets and liabilities. In addition, banks keep only a fraction of the deposits as cash. What is not loaned out gets used to purchase bonds with a higher yield than what is paid on customer deposits.

This is how the bank makes money.

As the Fed hiked rates to 2, 3, and 4%, the interest on bank accounts remained low, and deposits remained stable, providing a false sense of security for regulators. However, once rates eclipsed 4%, customers took notice and began to buy bonds directly for a higher yield or transfer funds from the bank to a brokerage account. Banks are forced to sell collateral at discounted values as customers extract deposits.

The Fed caused this problem by aggressively hiking rates which dropped collateral values. Such has left some banks, which didn’t hedge their loan/bond portfolios with insufficient collateral to cover the deposits during a “bank run.”

Here is a simplistic example.

  • Bank (A) has $100 million in deposits and $100 million in collateral trading at par (face) value.
  • As the Fed hikes rates, the collateral value falls to $90 million.

Again, this is not problematic as long as customers do not simultaneously demand all $100 million in deposits. If they do, there is a collateral shortfall of $10 million to cover demands. Further, the bank must recognize a $10 million loss and raise appropriate capital. Often, bank capital raises scare investors.

Such is precisely what happened with Silicon Valley Bank, as $42 billion was extracted from the bank literally overnight.

How did that happen?

Mobile banking.

Individuals no longer have to drive to the bank and wait in line to withdraw their funds. It is as fast as opening an app on your phone and clicking a button.

This should scare the “bejeebers” out of regulators.

A $17 Trillion deposit base is now on a “hair trigger” of consumers expecting instant liquidity.

The real problem for the Fed is not just bank solvency but “instant liquidity.”

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This Is Likely Only The Start

The events of Silicon Valley Bank should not be a surprise. As noted over the past year, there has never been a “soft landing” in the economy. Notably, this is not the first banking crisis the Fed has caused.

“The failure of Continental Illinois National Bank and Trust Company in 1984, the largest in U.S. history at the time, and its subsequent rescue gave rise to the term “too big to fail.” The Chicago-based bank was the seventh-largest bank in the United States and the largest in the Midwest, with approximately $40 billion in assets. Its failure raised important questions about whether large banks should receive differential treatment in the event of failure.

The bank took action to stabilize its balance sheet in 1982 and 1983. But in 1984, the bank posted that its nonperforming loans had suddenly increased by $400 million to $2.3 billion. On May 10, 1984, rumors of the bank’s insolvency sparked a huge run by its depositors.”

Many factors led to the crisis, but as the Fed hiked rates, higher interest service led to debt defaults and, eventually, the bank’s failure.

We saw the same impact from the Fed in 1994 with the bond market crash and even Bear Stears in 2007. At each point, the Fed was aggressively hiking rates to the point that it “broke something.”

The Fed remains abundantly clear that it still sees inflation as a “persistent and pernicious” economic threat that must be defeated. The problem is that higher rates in an economy dependent on debt for economic growth eventually lead to an “event” as borrowing costs and payments increase.

WHy rates can't rise much.

Such is why consumer delinquencies are now rising due to the massive amount of credit at higher rates. Notice that when the Fed begins cutting rates, delinquencies decline sharply. This is because the Fed has “broken something” economically, and debt is discharged through foreclosures, bankruptcies, and loan modifications.

Consumer credit delinquencies annual rate of change.

While the economy seems to be holding up well, this is the first crack in the “soft landing” scenario.

The Federal Reserve has never entered a rate hiking campaign with a” positive outcome.” Instead, each previous attempt resulted in a recession, bear market, or some “event” requiring a monetary policy reversal.

Or, instead, a “hard landing.”

I am pretty sure this time won’t be any different.

Silicon Valley Bank Default Rattles the Markets

Banking is relatively simple, they raise deposits and lend money. To do so successfully, a bank must manage a few risks. First, they need to duration hedge to address the difference between short-term deposit rates and the interest rate they lent money stays positive. Second, they hedge the credit and price risk of their assets. Lastly, and most importantly, they must keep deposits in the bank. The FDIC put Silicon Valley Bank (SVB) into receivership because it did not correctly hedge its loan/asset book. As a result, they took a $1.8 billion loss, scared depositors, and induced a bank run. As depositors pulled their funds, Silicon Valley Bank had to sell more underwater assets. Silicon Valley Bank is the second largest bank failure in the U.S., behind Washington Mutual in 2008.

Banking is a confidence game. The problem facing Silicon Valley Bank and potentially others is that many assets are underwater due to the sharp increase in yields. Below, we dive into bank balance sheets to better explain SVB’s problem. Bank stocks, especially regional banks, are falling in sympathy with SVB. Investors are concerned that banks were not well enough hedged for the sharp rise in interest rates. Hence, they would have to recognize significant losses if deposits leave. Through 2022, banks are sitting on about $700 billion in losses.

bank banking unrealized losses

What To Watch Today


  • No notable reports today



Market Trading Update

The news that SVB Financial Group was forced into receivership by the FDIC panicked investors and sparked fears of a liquidity crisis amongst regional banks.

Regional Bank ETF

The crack in regional banks is likely only starting as the Fed continues to hike interest rates, leading to more underperforming loans and reduced funding. Unlike the big banks, which have access to capital markets and trading revenues to offset traditional banking incomes, smaller banks have exposure to real estate, consumer, and small business loans that are more sensitive to increased borrowing costs.

Banks – and especially small banks – are now sitting with reserves pretty much at their lowest comfort level, There is not much of a cash-to-asset cushion left for small banks as a whole, so a funding crisis can easily get rolling if large depositors decide too many loans in commercial real estate and other areas are about to go bad. The Fed will make funds available to keep these banks afloat, but that alone will get some push-back from Congress because of the increased concentration of bank deposits in an increasingly smaller number of banks.” – Steven Blitz, TS Lombard

With that, the market took out the support at the rising trend line and the 200-DMA, which violated our stop-loss levels, where we reduced exposure to equities. With all of the previous bullish support levels broken, the next logical level of support is the December lows. A failure there will then set supports at the June and October lows.

Testimony, Testimony From Powell Kills Pivot Hopes

The one-two punch of Jerome Powell and SVB has put the bears back in control of the market. Unfortunately, the problem for the regional banks, corporate earnings, and the market is likely starting to gain traction. Use rallies to reduce equity risk and add Treasury bond exposure.

Fed Bailouts Begin

Last night the Fed, FDIC and the Treasury made a joint statement to provide a liquidity facility for banks.

As the WSJ’s Ben Eisen recaps,

“The facility will allow banks to take advances from the Fed for up to a year by pledging Treasury’s, mortgage backed bonds and other debt as collateral.”

By allowing banks to pledge their bonds – not just at current market price but at cost (or at par) –  banks can meet customer withdrawals without selling their bonds at a loss. Of course, that is what Silicon Valley Bank did last week, sparking a run on the bank.

Indeed, as Eisen underscores, the biggest draw of this facility is that “banks can borrow funds equal to the par value of the collateral they pledge, according to the Fed’s announcement. This means that the Fed won’t look to the market value of the collateral, which in many cases reflect big unrealized losses due to the jump in interest rates.”

That is a huge gift for the banks which are sitting on some $620 billion in unrealized losses on all securities (both Available for Sale and Held to Maturity) at the end of last year, according to the Federal Deposit Insurance Corp. It also means that just the Big 4 banks – as shown in the chart above – are getting a $210 billion bailout.Zerohedge

The Fed also won’t demand that banks pledge collateral above the advances they are taking, which is typically the case when banks borrow from the Federal Home Loan Bank system for example.

And if banks can’t repay all the advances in a year? The Treasury Department is providing $25 billion of credit protection to the Fed just in case. 

“The Federal Reserve does not anticipate that it will be necessary to draw on these backstop funds,” the Fed said in its announcement Sunday night.

That, in a nutshell, is how the bank bailouts have began.

The Week Ahead

CPI on Tuesday and PPI and Retail Sales on Wednesday will highlight economic data this week. After last month’s hot inflation prints, the Fed and investors could use weaker inflation figures. Monthly CPI is expected to rise 0.6%, a tenth higher than last month, and the annual rate is forecast to fall from 6.4% to 6.0%. After last month’s massive retail sales gains, forecasters expect a slight decline.

The Fed will be quiet this week as they are in their pre-FOMC meeting media blackout period. Consequently, we suspect they will speak through the Wall Street Journal if they have anything to say about monetary policy or the banking sector.

The BLS Jobs Report

Once again, payrolls grew by more than estimates. In February, 311k jobs were added versus forecasts of 225k. The unemployment rate did tick up to 3.6% from 3.4% because the participation rate rose to its highest level in three years. 419,000 people entered the labor force in February. The unemployment rate rose because more people were looking for jobs, not due to layoffs. If this continues, the growing workforce should help reduce job openings and bring the labor market back into balance. Such would weigh on wages and lower the risks of a price-wage spiral.

Average hourly earnings only rose 0.2%, and weekly hours worked fell by a tenth of a percent. The data, on its own, will do little to change the Fed’s decision on whether to increase rates by 25 or 50bps at the March 22 meeting.

bls jobs report employment payrolls

Dissecting Bank Balance Sheets To Appreciate SVB’s Problem

We examine aggregated bank balance sheet data from the Federal Reserve’s H.8 report to understand Silicon Valley Bank’s default better. The pie charts below break down commercial banks’ aggregate assets and liabilities.

The banks’ asset side is predominately a portfolio of fixed-income securities and loans. Not all of the assets are liquid. Of the assets shown below, 47% can be quickly sold to raise capital/liquidity. Besides cash and potentially trading assets, most of the Treasury securities and MBS likely have significant unrealized losses. While the loans are not often liquid and, in some cases, not tradable, their values (prices) are also underwater. If a bank properly hedges, hedge gains should offset most current losses. However, as in the case of Silicon Valley Bank, they did not hedge properly. As a result, the combination of price markdowns and deposit losses left the bank with no choice but to have a firesale, recognize losses, and try to raise capital. They couldn’t raise enough capital and were put into receivership.

commercial banking bank assets balance sheet

Deposits are the banks’ funding lifeline, accounting for over 85% of their liabilities. When a bank loses deposits, it must shed assets to keep its leverage and capital ratios in check. When assets are poorly hedged and underwater, they must sell more assets and take larger losses for each lost deposit. Such begets more deposits to leave, and a circular problem ensues.

The second graph below shows that banking deposits are falling for the first time in at least 45 years. Depositors are seeking much higher yields in money market funds and other alternatives. Bank stock investors are losing confidence as banks must sell assets to offset deposit declines, potentially entering into a death spiral like SVB if the bank did a poor hedging job.

commercial banking bank liabilities balance sheet
commercial bank deposits

Tweet of the Day

four largest banks lose 47 billion in market cap

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Delinquent Consumer Loans on the Rise

The chart below showing delinquent consumer loans is concerning but misleading. At first blush, the number of delinquent consumer loans is nearing the peak of the 2008 recession. That stat should be very worrisome on its own. However, the amount of consumer loans has more than doubled since 2008. Therefore, the percentage of delinquent consumer loans is only half of the 2008 peak.

While the percentage of delinquent consumer loans is not problematic, the sharply rising trend is. Further, Heather Long of the Washington Post notes, “Many households are also behind on their utility bills: 20.5 million homes had overdue balances in January, according to the National Energy Assistance Directors Association.” Per the article, the bottom 60% of earners contribute about 40% of GDP growth. People delinquent on loans are likely getting financially squeezed due to falling real wages and will be forced to reduce their consumption. If the unemployment rate rises, the problem will worsen. The article ends as follows: “The flares are going off. If the economy does fall into a recession, it will only get more perilous for those at the bottom.

delinquent consumer loans

What To Watch Today


economic data



Market Cracks Important Support

Yesterday, news that SVB Financial Group was taking “steps to bolster its financial position.” That included a highly dilutive stock offering and a panicked asset sale that sparked fears of a liquidity crisis at one of the biggest and original funding providers to the Venture Capital industry. The fear spread through other regional banks as a concern of “one roach in the kitchen” may mean a lot more at risk. The ETF of Regional Banks (KRE) dropped sharply.

Regional Bank Stocks

The crack in regional banks is likely only just starting as the Fed continues to hike interest rates, leading to more underperforming loans and reduced funding. Unlike the big banks, which have access to capital markets and trading revenues to offset traditional banking incomes. smaller banks have a lot of exposure to real estate, particularly commercial.

Banks – and especially small banks – are now sitting with reserves pretty much at their lowest comfort level, There is not much of a cash-to-asset cushion left for small banks as a whole, so a funding crisis can easily get rolling if large depositors decide too many loans in commercial real estate and other areas are about to go bad. The Fed will make funds available to keep these banks afloat, but that alone will get some push-back from Congress because of the increased concentration of bank deposits in an increasingly smaller number of banks.” – Steven Blitz, TS Lombard

With that, the market dropped about 1.85% yesterday as concerns of a contagion spread through the financial sector, and given its large weight in the index, contributed to the selloff.

Today is critical for the markets to muster a bit of a reflexive rally to retake the broken trend line and the 200-DMA, which is key support. The selloff yesterday also kept sell signals intact. A weaker-than-expected employment number could provide a lift if the bulls get any data to support the hope of a “pivot” by the Fed.

Market Trading Update

Today will be a critical test of broken support. Stay tuned.

Employment Preview

On Wednesday, ADP and the JOLTs report gave investors a preview of what to expect in this morning’s BLS labor report.

ADP reported payrolls grew by 242k, more than double last month’s +119k and estimates of 200k. Small businesses lost employees, while large ones added jobs. Today’s Tweet of the Day, shown below, sheds light on why small business employment continues to decline while employment is generally rising for midsize and large companies. Once again, the leisure and hospitality sectors added the most jobs. ADP wage growth showed a year-over-year gain of 7.2%, .10% below last month’s level, but likely way too high for the Fed’s liking.

JOLTs showed similar strength but contained concerning data points. The number of job openings fell from 11.234 million to 10.824 million. The graph below shows that the ratio of job openings to unemployed workers remains well above the levels of the last 20 years.

Of concern, 241k people were laid off last month. That is the fourth-highest monthly increase in 20 years. Also worrisome, construction job openings fell by 240k. The third graph below shows that last month’s decline in construction job openings is almost three times larger than the second-worst decline in the last 20 years. Construction employment usually leads the broader labor market because it is very interest rate sensitive. Might the interest rate hike lag finally be catching up to the economy? Keep an eye on the construction employment in today’s BLS report.

job openings payrolls employment
jolts layoffs employment jobs
job openings construction

Continuing Jobless Claims

Continuing jobless claims is the number of people that filed initial jobless claims but unable to find a new job. Increasing continuing claims is often a leading indicator of weakness in the labor market.

Continuing claims rose this week to 1.718 million from 1.649 million. The matches the high we saw in mid-December. One number does not make a trend. But, if continuing claims continue upward, we should expect the unemployment rate to increase.

The graph below shows that continued claims match their highest level in over a year. However, today’s data is only on par with pre-pandemic levels.

continued jobless claims rising

Will Economists Come Up Short Again on Payrolls?

The graph and tweet below point to the amazing streak economists have had in underestimating the strength of the labor market. After reporting 517k new jobs last month, will today’s 223k estimate be short again?

payrolls employment economists misses

Tweet of the Day

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Buffett On Buybacks

Warren Buffett defended stock buybacks in Berkshire Hathaway’s annual letter, pushing back on those railing against the practice he believes benefits all shareholders.

“When you are told that all repurchases are harmful to shareholders or to the country, or particularly beneficial to CEOs, you are listening to either an economic illiterate or a silver-tongued demagogue (characters that are not mutually exclusive).”

The media latched on to this quote with both hands, apparently not taking the time to read what Warren Buffett actually wrote in his annual letter. (Emphasis mine.)

“The math isn’t complicated: When the share count goes down, your interest in our many businesses goes up. Every small bit helps if repurchases are made at value-accretive prices.

Just as surely, when a company overpays for repurchases, the continuing shareholders lose. At such times, gains flow only to the selling shareholders and to the friendly, but expensive, investment banker who recommended the foolish purchases.

Gains from value-accretive repurchases, it should be emphasized, benefit all owners – in every respect.”

Mr. Buffett is correct that if repurchases are done at a “value-accretive” price, they can benefit all shareholders by increasing the size of their ownership in the company. Unlike the mainstream narrative, this is NOT a “return of capital to shareholders,” but just the opposite of a shareholder dilution.

Unfortunately, while the mainstream media quickly jumped on those opposed to share repurchases, their lack of reading what Mr. Buffett stated is critically important to what is happening in the financial markets today.

A Basic Example

I have discussed the problems with stock buybacks previously. But let’s start with a simple example of what happens with stock buybacks.

“Share repurchases in and of themselves are not necessarily a bad thing, it is just the least best use of cash. Instead of using cash to expand production, increase sales, acquire competitors, or buy into new products or services, the cash is used to reduce the outstanding share count and artificially inflate earnings per share. Here is a simple example:”

  • Company A earns $1 / share, with 10 / shares outstanding. 
  • Earnings Per Share (EPS) = $0.10/share.
  • Company A uses all of its cash to buy back 5 shares.
  • Next year, Company A earns $0.20/share ($1 / 5 shares)
  • Stock price rises because EPS jumped by 100%.
  • However, since the company used all of its cash to buy back the shares, it had nothing left to grow its business.
  • The following year Company A still earns $1/share, and EPS remains at $0.20/share.
  • Stock price falls because of 0% growth over the year. 

“This is a bit of an extreme example but shows the point that share repurchases have a limited, one-time effect, on the company. This is why once a company engages in share repurchases they are inevitably trapped into continuing to repurchase shares to keep asset prices elevated. This diverts ever-increasing amounts of cash from productive investments and takes away from longer term profit and growth.”

As shown in the chart below, the share count of public corporations has dropped sharply over the last decade as companies rush to shore up bottom-line earnings to beat Wall Street estimates against a backdrop of a slowly growing economy and sales.

(The chart below shows the differential added per share via stock backs. It also shows the cumulative growth in EPS and Revenue/Share since 2011) You will notice that while operating earnings per share have surged, actual sales remains very weak.

As Mr. Buffett states, buybacks done on a value-accretive basis benefit shareholders. However, that has not happened since the turn of the century.

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Mostly Not Value-Accretive

“Over the past five years, according to S&P Dow Jones Indices, big U.S. companies have spent $3.9 trillion repurchasing their own stock.

Buybacks are neither bad nor good. They are simply a tool. Just as you can use a hammer either to build a house or knock one down, buybacks are useful in the right corporate hands and dangerous in the wrong ones.Jason Zweig, WSJ

Jason is correct. Notably, the media overlooked another aspect of Buffett’s comment on share buybacks in their rush to support them. While Mr. Buffett was speaking about his repurchases of Berkshire Hathaway stock, he also noted that many managers do not report earnings properly.

“Finally, an important warning: Even the operating earnings figure we favor can easily be manipulated by managers who wish to do so. Such tampering is often considered sophisticated by CEOs, directors and their advisors.

Reporters and analysts embrace its existence as well. Beating ‘expectations’ is heralded as a managerial triumph. That activity is disgusting. It requires no talent to manipulate numbers: Only a deep desire to deceive is required. ‘Bold, imaginative accounting,’ as a CEO once described his deception to me, has become one of the shames of capitalism.

This manipulation of earnings through accounting gimmicks and buybacks is a topic I discussed previously on how companies stretch to “beat estimates.”

“The tricks are well-known: A difficult quarter can be made easier by releasing reserves set aside for a rainy day or recognizing revenues before sales are made, while a good quarter is often the time to hide a big ‘restructuring charge’ that would otherwise stand out like a sore thumb.

What is more surprising though is CFOs’ belief that these practices leave a significant mark on companies’ reported profits and losses. When asked about the magnitude of the earnings misrepresentation, the study’s respondents said it was around 10% of earnings per share. – WSJ

Unsurprisingly, 93% of those surveyed pointed to “influence on stock price” and “outside pressure” as the reason for manipulating earnings figures.

However, the question is whether these buybacks were value-accretive to shareholders.

A new study, “Share Repurchases on Trial,” by accounting and finance professors Nicholas Guest of Cornell University, S.P. Kothari of the Massachusetts Institute of Technology and Parth Venkat of the University of Alabama, analyzes the stock returns of thousands of companies from 1988-2020, comparing those that repurchased shares against firms that didn’t, adjusting for their size and other factors. In the year of a repurchase, companies that did large or frequent buybacks had slightly lower—not higher—returns. Over longer periods, their returns were indistinguishable.” – Jason Zweig

Clearly, if there is no real benefit to higher returns, then the buybacks were not value-accretive to shareholders. Which then fosters the question, why do they continue to do it?

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Who Really Benefits

Share buybacks only return money to those individuals who sell their stock. This is an open market transaction, so if Apple (AAPL) buys back some of its outstanding stock, the only people who receive any capital are those who sold their shares.

So, who are the ones mostly selling their shares?

It’s the insiders, of course, as changes in wage structures since the turn of the century became heavily dependent on stock-based compensation. Insiders often sell shares “given” to them as part of their overall compensation structure to convert them into actual wealth. As the Financial Times previously penned:

“Corporate executives give several reasons for stock buybacks but none of them has close to the explanatory power of this simple truth: Stock-based instruments make up the majority of their pay and in the short-term buybacks drive up stock prices.

A report on a study by the Securities & Exchange Commission found the same:

  • SEC research found that many corporate executives sell significant amounts of their own shares after their companies announce stock buybacks, Yahoo Finance reports.

What is clear is that the misuse and abuse of share buybacks to manipulate earnings and reward insiders has become problematic.

Stock Buybacks Do Help Keep The Market Afloat

As John Authers pointed out:

“For much of the last decade, companies buying their own shares have accounted for all net purchases. The total amount of stock bought back by companies since the 2008 crisis even exceeds the Federal Reserve’s spending on buying bonds over the same period as part of quantitative easing. Both pushed up asset prices.”

In other words, between the Federal Reserve injecting massive liquidity into the financial markets and corporations buying back their shares, there have been no other real buyers in the market. 

U.S. stocks have received support from a key source during 2023’s shaky market environment: companies repurchasing their own shares.

Stock buybacks by companies in the S&P 500 are projected to top $1 trillion in 2023 for the first time in a calendar year, according to S&P Dow Jones Indices. Authorizations for repurchases are picking up pace: As of Feb. 17, they totaled more than $220 billion, a record for that point in the year, according to a Goldman Sachs analysis of S&P 500 and Russell 3000 companies.” – Jannah Miao, WSJ

The chart below via Pavilion Global Markets shows the impact stock buybacks have had on the market over the last decade. The returns for the S&P 500 breaks down as follows:

  • 6.1% from multiple expansions (21% at Peak),
  • 57.3% from earnings (31.4% at Peak),
  • 9.1% from dividends (7.1% at Peak), and
  • 27% from share buybacks (40.5% at Peak)
Buyback contribution

While Mr. Buffett is correct that share buybacks benefit shareholders at value-accretive prices, that has not been the case for most corporate actions.

Instead, money that could have been spent for future growth was wasted only benefiting senior executives paid based on fallacious earnings-per-share.

While Mr. Buffett supports the practice of share buybacks, there is a significant difference between what he is doing for Berkshire’s stakeholders and what is happening in the rest of the market.

Of course, that is probably why the SEC had banned stock buybacks until 1990, as they were a form of stock market manipulation.

Tightening Phase 2, More QT?

Over the last twelve months, the Fed has been tightening policy at its most aggressive pace in over 40 years. The Fed’s tightening actions include raising the Fed Funds rate by 4.50% in twelve months and performing $95 billion monthly QT. As the graph below shows, the increase in Fed Funds occurred at nearly double the rate of those in the last forty years. Despite the Fed’s aggressiveness, inflation is still high, and economic activity is brisk. To slay inflation, Powell and the Fed will need to do more.

We advise Jerome Powell in our latest, Speak Loudly Because You Carry a Small Stick. The gist of the article is the Fed risks creating massive financial turmoil if it continues to raise rates at such an aggressive pace. Therefore, the Fed should speak more hawkishly to tighten financial conditions. As an afterthought to the article, supplementing a slower pace of rate tightening with more significant amounts of QT is another option. Currently, the $95 billion of monthly QT is offset by the Fed’s reverse repurchase program and the drawdown of the Treasury’s General Account. Boosting QT beyond the offsets would reduce liquidity in the system helping the Fed’s cause while lessening the risk of pushing the Fed Funds rate too high.

fed funds rate of change powell

What To Watch Today





Market Trading Update

The stock market struggled again yesterday as more hawkish comments from Jerome Powell weighed on investors. The rhetoric of “higher for longer” is finally becoming a reality for the markets as inflationary pressures remain. Powell’s two days of testimony have been about as hawkish as we could have imagined, and with the odds of a 0.50% rate hike rising markedly, the sell-off was not surprising.

The good news is that the market continues to hold support at the 200-DMA and bounced off the rising trend line yesterday. The bullish trend remains intact despite the sell-off. Even with more hawkish commentary yesterday, bullish buyers stepped in late in the session. This Friday is the much anticipated February jobs report. A strong report will likely send stocks lower as support for further rate hikes continues. We are overweight cash currently and will remain that way until the market either reaffirms support at the 200-DMA or violates that support confirming the bullish rally from the October lows is over.

Market Trading Update 1

Jerome Powell Has Tough Choices Ahead

On the first day of testimony to Congress, Jerome Powell stated:


This comment caught the attention of Senator Elizabeth Warren and other Senators. She warned Powell that 2 million people could lose their jobs if the Fed keeps raising rates. To that, Powell replied

“Will working people be better off if we just walk away from our jobs and inflation remains 5%-6%?”

The conversation got more heated.

Warren: Since the end of WWII, there have been 12 times unemployment has gone up by 1% within a year. How many of those times did the US avoid a recession?

Powell: Not that black and white.

Warren: It is.

Powell: I think the number is zero.

Warren: Exactly right.

As we share below, Warren and Powell are correct. A 1% increase in the unemployment rate has always coincided with a recession. This is the Fed’s trap. They need a higher unemployment rate and reduced consumption to bring inflation down. The Fed often counteracts economic weakness and rising unemployment with lower interest rates. This time is different, and the worsening political theater we share above will only worsen if the Fed keeps raising rates. Therefore, as noted in the opening, More QT may be the better Fed option.

unemployment rate powell decision

The Housing Market is Broken

In a recent Commentary, we opined on the current standstill in the housing market. Given high prices and mortgage rates, we quantify why buying or selling a house makes little sense for many people.

We present the following example to show how high mortgage rates limit supply and demand in the housing market and keep the labor market tighter than it should be.

Assume a homeowner has a 3.50% mortgage on a $500,000 house. Their monthly payment is $2,245, excluding taxes and insurance. To incur the same monthly mortgage payment at current mortgage rates, the homeowner can only afford a house worth $335,000. Even if they put $100,000 down, making it a $400,000 mortgage, the monthly payment would still increase by roughly $400. The demand for housing will weaken as a result. Further, the labor market will remain tight as employees may be unable to move for a new job.

Buying makes little sense for most homeowners or potential homeowners. At the same time, selling for homeowners looking to upsize or downsize also makes little sense. As such, activity in many real estate markets has slowed appreciably. The scatter plot below from Longview Economics diagrams what must change to restart the housing market. The correlation linking mortgage rates and home prices has been relatively strong until the last two years. If we look at the latest dot (Dec 2022), we can calculate what has to happen for some balance in the housing market to return. Either house prices must drop considerably, or mortgage rates plummet. It will likely be a combination of both, primarily if a recession occurs.

standstill in the housing market

Foreign Stock Markets Cooling Off

Foreign developed and emerging markets were on a tear late last year and early this year: the culprit a weaker dollar. As we see in the chart below from Y-Charts, the dollar has recouped some recent losses and is back to levels seen late last year. As a result, only 32% of markets are above their respective 50dma compared to 91% at the start of the year. The percentage above their 200dma’s is also starting to decline.

foreign market breadth dollar

Tweet of the Day

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Five Ways to Raise Money-Smart Kids: Part One.

In Five Ways to Raise Money-Smart Kids: Part One, I explore practical methods and teachable moments to help young children and teens build their fiscal muscles with ongoing help from mom and dad.

First, financial literacy is fair or average across the globe. Per insights from the recent Standard & Poor’s Global Financial Literacy Survey:

Financial literacy rates differ enormously between the world’s major advanced and emerging economies. On average, 55 percent of adults in the major advanced economies–Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States–are financially literate. In contrast, in the major emerging economies—the so-called BRICS (Brazil, the Russian Federation, India, China, and South Africa)—on average, 28 percent of adults are financially literate.

Second, as a country, we can do better. As a household, we can do our best. It’s up to parents and grandparents to help the next generation build skills to make sound financial decisions. The process begins with teaching the long-term benefits of delayed gratification.

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Lessons from the Stanford marshmallow experiment.

In 1972, psychologist Walter Mischel at Stanford University began the marshmallow experiment. He explored what made preschool children temper immediate gratification in exchange for a more significant delayed award.

Per the Bing School at Stanford:

These studies showed how self-control and emotion regulation could be taught and learned beginning very early in life, even by children who initially had difficulty delaying gratification.

The Bing research also yielded a surprise: What the preschoolers did as they tried to wait unexpectedly predicted much about their future lives. “The more seconds they waited at age 4 or 5, the higher their SAT scores and the better their rated social and cognitive function in adolescence,” Mischel wrote in his book about the Marshmallow Test.

Children who waited longer tended to become more self-reliant and better able to cope with stress as adolescents.

Delayed gratification: A key to building financial discipline and a secure future.

Thirdly, teaching children to delay gratification is the gateway to financial literacy. Children and teens who wait to purchase or weigh the pros and cons of spending money will likely save for long-term goals and resist impulse purchases. As a result, the concept of ‘pay yourself first’ takes on significance. The kids grow to be adults who prioritize saving and investing.

Last, in Part Two of Raising Money-Smart Kids, I provide tips to help parents coach their kids on immediate gratification.

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Five ways to raise money-smart kids: Part One. Where do parents start?

Know yourself, and understand them.

Children observe your ‘relationship’ with money. They’re forging their personal money script with your help, like it or not. Household money and debt management habits will either develop positive habits or accentuate negative ones. They can even propel your kids in the opposite direction, perhaps to an extreme.

For example, my parents were terrible with money. They rarely saved, overspent, and ultimately left debts behind when they died. As a result, financial insecurity is a fear of mine. Thus, my dominant Money Script is vigilance. Perhaps, too much so.

Dad would have benefited from five ways to raise money-smart kids!

My father was a great example of a money-status seeker, as he always required the trendiest clothing, the flashiest jewelry, and the hottest car. Don’t get me wrong. I loved my father but learned what not to do from his relationship with money. Although not dominant, Money Vigilance is also part of my financial imprint. As a result of understanding my Money Script®, I am mindful of the behavior and recognize and control it.

Money Scripts® is a concept created by financial psychologists Brad and Ted Klontz. They are unconscious, trans-generational beliefs about money developed in childhood and drive adult financial behaviors.

Basically, there are four categories:

  1. Avoiders believe money is evil and rich people are greedy.

2. Worshippers believe more money will solve all their problems.

3. Status seekers equate self-worth to net worth and place a premium on buying the newest and best things.

4. Vigilance is exhibited by those who are alert, watchful, and concerned about their financial health.

Do you dare to understand your Money Scripts®? Five Ways to Raise Money Smart Kids: Part One needs you, as a parent or grandparent, to get a handle on your personal money DNA.

You can receive a complimentary KMSI-R at Or, head to and click on Insights. From there, scroll down to Guides. Sign up, and take our Millionaire Next Door quiz. Once completed, you’ll receive an e-mail link to take the Money Script® assessment and find out where you stand!

Aren’t you excited?

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Overall, money scripts are always learned in childhood, often unconscious, passed down through the generations, partial truths, and responsible for our financial outcomes.

Once your Money Script® examination is complete, you’ve analyzed the report, and you understand your dominant and secondary money script behavior, we’re ready to move on.

Five Ways to Raise Money Smart Kids: Part Two includes ways for parents to recognize Money Scripts® signs in their children and lessons to teach.

In conclusion, Five Steps to Raise Money Smart Kids: Part One is designed to direct you and your children to a lifetime of money awareness, security, and wealth.

Bank Profit Margins At Risk

The yield curve is often used as a proxy for bank profit margins. The logic is that banks tend to borrow short-term and lend for longer terms. Therefore the difference between a bank’s short-term borrowing rate and long-term lending rates approximates its profit margins. As we have discussed numerous times, the yield curve has inverted to levels last seen in the early 1980s. At first blush, the inversion should be horrendous for bank profit margins. That is not the case.

Fortunately, at least for banks, a good percentage of deposits, representing about 85% of bank borrowing, has been near zero percent while lending rates zoomed higher. That large margin may be ending. As the graph below shows, deposits at commercial banks are falling for the first time since at least 1975. According to Bloomberg, 1948 was the last year deposits declined. Banks will have to offer more competitive rates to hold onto their deposits. Therefore, bank profit margins are likely to shrink. Further, bank lending standards will continue to tighten as banks have fewer deposits to meet reserve and capital requirements.

bank deposits profit margins

What To Watch Today


Economic Calendar



Why We Started Buying Bonds Yesterday

Yesterday, we alerted our SimpleVisor subscribers that we started buying longer-duration bonds. We have recently discussed beginning to shift the duration of our bond holdings to a longer-term time frame in anticipation of economic weakness and an eventual reversal of Fed policy. We started by shifting 1-3 month Treasuries (BIL) to 1-3 year Treasuries (SHY). Today, with our “money flow buy signal” triggering from an oversold level, we are bringing the iShares 20-Year Treasury ETF (TLT) to target weight. We will build on this small move as we continue to slowly lengthen the duration of the overall bond holdings in our portfolios.

Portfolio Trade Alert - 03-07-23, Portfolio Trade Alert – March 7, 2023

As discussed below, the Federal Reserve’s speech before the Senate Finance Committee lacked the “pivot” the bulls sought. More importantly, the Fed’s more aggressive stance on combatting inflation continues to increase the odds they will “break something” economically before they are done. If, and when, such an event occurs, and the Fed begins to cut rates, the long end of the yield curve will drop dramatically. We want to be well-positioned before that happens.

Powell Upsets the Bulls

As we suspected, Jerome Powell, in his testimony to Congress, said the Fed would resort to steeper rate hikes if economic strength continues. The stock market did not like his hawkishness. It appears many investors were looking for a more pragmatic Fed. One is willing to look beyond recent inflation and labor data and not be too aggressive with further rate hikes. With interest rates already very high for such a leveraged economy, the Fed will have to be more hawkish to compensate for the limits to raising rates.

“If the totality of the data were to indicate that faster tightening is warranted, we would be prepared to increase the pace of rate hikes.”

Powell poured cold water on the wishful thinking for a Fed pivot. The only pivot we see with Tuesday’s speech was a pivot from hawkish to more hawkish.

“The historical record cautions strongly against prematurely loosening policy. We will stay the course until the job is done.”

Following his opening speech, Fed Funds futures increased the odds of a 50bps rate hike at the march 22nd meeting to 70%. Before the speech, it was around 25%.

Stock vs. Bond Volatility

The graph below from SpotGamma shows the tight correlation between the volatility of stocks and bonds. However, the strong correlation for the last year has diverged over the previous month. The bond market has been selling off, fearing the Fed’s hawkish outlook. Stocks have largely ignored the Fed and seem to be banking on a no-landing or, worst case, a soft-landing economic scenario. With Powell on the docket again today, the labor report on Friday, and CPI next week, we must consider if the divergence can maintain itself or how does it resume its relationship.

stock and bond volatility

Supply Lines Are Not The Inflation Problem Anymore

Last year, inflation surged as demand was robust and supply lines fractured due to the pandemic. The graph below from Liz Ann Sonders of Charles Schwab shows the ISM supplier delivery indexes are now at their lowest since the 2008 recession. This is just one of many pieces of data pointing to the demand side as the predominant reason inflation remains high. Sonders writes:

Supply chain bottlenecks clearly in rearview as supplier deliveries components of both ISM Manufacturing and Services PMIs remain firmly in contraction

supplier deliveries ism

Tweet of the Day

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Speak Loudly Because You Carry A Small Stick

The big question facing the Fed is whether they should increase the Fed Funds rate by 25bps or 50bps on March 22, 2023. If Jerome Powell cared for our advice, we would tell him to take the opposite approach of President Theodore Roosevelt. Speak loudly because your stick isn’t that big anymore.  

President Roosevelt’s “big stick diplomacy” defined his foreign policy leadership style. He believed that the U.S. should negotiate with allies and foes peacefully (softly), but making it well understood, the U.S. was prepared to strike hard (big stick) if need be.

Having raised rates by over 4%, over a short period and in a very leveraged economy, the Fed no longer has the big stick it used to have. Therefore, speaking loudly with hawkish rhetoric and narrative must become a priority.

Current Monetary Policy Stance

The Fed has used its large interest rate stick for the last year to thump the economy and tame inflation. Their monetary policy actions are more aggressive than any we have seen in over forty years, yet have thus far proven futile.

The graph below shows Fed Funds (blue) and the 12-month rate of change in Fed Funds (orange). The orange dotted line shows that the current 12-month rate of change in Fed Funds is double that of any period since 1981.

fed funds monetary policy

Fed Funds are at 4.50% and expected to climb to 5.25% in the coming months.

Despite the forceful interest rate hikes, the unemployment rate is at 50-year lows, and GDP is trending above the natural growth rate. CPI appears to have peaked, but recent inflation indicators warn it may be sticky at levels higher than the Fed wants. While the economy may seem robust and inflation too high, both can change quickly as the leverage tax exerts itself.

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The Leverage Tax

We use the term leverage tax to describe the cost of interest expense on the economy. To better comprehend it, think about buying a car on loan. The initial purchase will boost your consumption significantly. Yet the monthly loan payment reduces the goods and services you can consume until the loan is retired, your income increases, or you can refinance at a lower interest rate. The loan impedes your ability to spend.

From a macroeconomic perspective, the leverage tax is a function of the total amount of debt in the system, the debt’s interest rate, and GDP. The table below compares the current amount of system-wide leverage versus 2000.

debt to gdp leverage

As it shows, the amount of debt today has risen to 2.75 times that of the size of the economy, having grown significantly over the last 20 years. While there is more debt as a percentage of GDP, the leverage tax did not increase nearly as much.

Since 2000, total debt has risen 264%, yet the interest expense on the debt is only up 40%. Such is the magic of declining interest rates.

As shown below, interest rates have fallen significantly since 2000. More debt drove economic activity but, on the margin, did not increase the future financial burden significantly.

bond yields interest rates

Interest Rate Magic No More

Interest rates are now rising rapidly, and the leverage tax will follow. To help quantify the increasing burden, we share the table below.

leverage value of 1% in rates per gdp

The table estimates how each 1% increase in interest rate costs the economy as a percentage of GDP. Before panicking, realize that most of the debt has a fixed interest rate. As such it will take time to reset at higher levels.

We use the five-year Treasury as a proxy for interest rates to approximate how higher interest rates will dampen the economy over time. The five-year note currently yields 4.25%, about 2.50% above its 1.75% average of the last 12 years. Most maturing debt was added when interest rates were below 2%.

If only 20% of debt matures this year and is rolled over, the additional interest cost could be equivalent to 1.38% of GDP. The percentage will continue to increase as more debt matures and gets reissued at higher rates.

The process whereby higher interest rates slowly but increasingly weaken the economy is known as the lag effect.

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HOPE and the Lag Effect

In Janet Yellen Should Focus On Hope, we employ the HOPE framework to show how higher interest rates take time to ripple through the economy.

Per the article:

The Fed first hiked rates on March 17, 2022, by .25%. Assuming it takes a year or longer for the full impacts of a rate hike to be experienced, the first, relatively small rate hike is not fully being felt. There were seven more after March 2022, accounting for an additional 4.25% of interest rate increases.

Graphing Hope

We make a few assumptions below to show when prior rate hikes will fully affect the economy. Rate hikes should affect the economy with the following lags:

  • 25% First month
  • 50% within three months
  • 75% within nine months
  • 85% within fifteen months
  • 100% within two years

The lags assumptions are estimates and likely conservative. The point is not to quantify the impossible but to raise awareness that interest rate hikes aren’t effective immediately. As the graph below shows, the Fed Funds rate as of mid-March is 4.50%. Yet the lagged-effective Fed Funds rate is likely about 2% less.

fed funds interest rates lagged

Time For the Fed to Manage Financial Conditions

The Fed has already raised Fed Funds significantly. But, it is as if the Fed only did about half of what they did do. The lagged Fed Funds rate is rising rapidly and will increasingly tax the economy significantly.

Does Powell want to increase the tax on tomorrow’s economy further? Or is he willing to wait for previous rate hikes to take full effect?

As we think about the question, remember that the amount of leverage in the system is significant and that higher rates risk the potential for serious financial difficulties. Therefore, Jerome Powell should aim to stop inflation with weaker “financial conditions” as his Fed Funds stick becomes increasingly dangerous to swing.  

Financial markets are a vital way monetary policy is transmitted to the broader economy. As such, higher stock prices, which Powell describes as “an unwarranted easing of financial conditions” driven by a dovish Fed, will further incite inflation, forcing the Fed to stay aggressive.

If Jerome Powell and the Fed can maintain a very hawkish tone and threaten higher rates for longer, the stock market may weaken and tighten financial conditions. Speaking loudly and hawkishly would help the Fed’s effort to tame inflation without further risking financial and economic catastrophe.

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The path ahead is fraught with risk for the Fed. On the one hand, they risk not doing enough regarding the actual policy to normalize inflation. On the other hand, they could raise rates too much and create a financial crisis.

Given the lag effect of prior rate hikes and the massive leverage embedded in the economy, we advise Jerome Powell to speak very loudly but take limited further action regarding rate hikes. If Powell takes our advice and speaks loudly, the stock market could return to last October’s lows or even lower. Regardless of whether such activity is taken, talk of more QT and higher Fed Funds will scare investors.

Putting ourselves in Powell’s seat and weighing the decisions he has to make is one way to appreciate better what the future may hold.

Bullish 0DTE Bets

0DTE options are speculative option trades that expire within a day of expiration. Furthermore, and very topical, the popularity of 0DTE options has accelerated immensely, accounting for over 50% of all options volume. Before the pre-pandemic era, 0DTE trading accounted for 5-10% of all options volume. Thus far, the interest is mainly for calls, i.e., bullish bets. While many 0DTE option trades are bullish, that may not always be the case. As we wrote in Turmoil Lurks Around the Corner, regardless of the objectives, 0DTE options have a similar feature as portfolio insurance; they can significantly intensify market moves.”

The graph below from SpotGamma sheds more light on 0DTE trades. It shows that most 0DTE trades are bullish. To get wonky- the delta of the underlying options rises as stock prices increase. Per SpotGamma: “whereas 0DTE is currently most impactful is where it seems 0DTE calls are being used to ‘buy the dips’ after large declines.” Such trades exaggerate upward moves. While everyone likes a good upward surge, nothing precludes 0DTE options traders from switching from bullish to bearish trades. In that case, turmoil may rear its ugly head.

bullish 0dte trading

What To Watch Today


  • Wholesale Inventories, January
  • Federal Reserve Chair Jerome Powell testifies before Senate Banking Committee


Earnings Data

Market Trading Update

The market rallied out of the gate yesterday morning and eclipsed the 20-DMA. However, it was unable to sustain that break into the afternoon. Importantly, the 100-DMA is now crossing above the 200-DMA, another bullish confirmation. While the economic and fundamental backdrop remains challenging, the market continues to ignore the “Elephant in the room” of the Federal Reserve continuing to tighten monetary policy.

Market Trading Update

Speaking of bullish technicals, Sentiment Trader posted a report yesterday showing market performance post “bear market lows.” If such is indeed the case. To wit:

“If we assume that October 12, 2022, was the birth of a new bull market, then by last week, the rally had lasted 95 trading days. We can use bull and bear market dates defined by Ned Davis Research to compare the price path during this stretch against all other nascent bull markets since 1928. By doing that, we can look at the highest- and lowest-correlated bull markets to see where the current one fits in and what the future returns looked like after similar behavior.

The chart below shows the current bull market in black versus the 15 highest-correlated ones dating back to 1928.”

Sentiment Trader 95 days from bear market lows

What’s most important is what it meant for future returns. The table below shows S&P returns after the first 95 days of the most highly-correlated bull markets. Those returns were good, especially over the next six months, with all positive returns.

S&P 500 returns post bear market lows

“Suppose a new bull market started last October. In that case, it has progressed in line with many of the more sustained bull markets in history, particularly since the 1950s. The first 95 trading days of the bull market (if that’s what this is) have a high correlation to the first 95 days of bull markets that showed a strong tendency to persist, with low drawdowns, at least over the next year. While a couple of those ultimately failed, the initial move off the low was compelling enough for buyers to continue to raise their bids for months afterward.”

Just something to consider.

REITs Trading at Discounts

S&P Global conducted recent research on the Net Asset Values (NAV) of U.S. equity REITs broken down by sector. In this case, the chart below shows the difference between the market cap of the aggregated REITs by sector and the reported value of the underlying properties. We caveat the research. Securing “good” valuations for properties is very difficult. Therefore, REITs are often delayed in reporting declines in property values. Investors, however, are not dumb and will often price in lower asset values before they are officially reported, resulting in price discounts to the NAV.

The first chart shows that only Casino and Communications REITs trade at a premium to their aggregate NAVs. Conversely, office REITs trade at the largest discounts. Further, the second table shows eight of the ten REITs trading at the largest discounts to NAVs are office REITs. Lastly, the third table shows the top ten REITs sorted by the premium to NAV.

reit price to nav by sector
bottom ten price to nav reits
reits top ten price to nav

Heikin Ashi Technical Analysis

Jim Colquitt uses Heikin Ashi, a not commonly used form of technical analysis, to analyze what may come next for the S&P 500. Per stock charts:

heikin ashi

Here is Jim’s technical take on the S&P 500 as seen through the eyes of Heiken Ashi Analysis:

Note that the even though the S&P 500 Index registered a positive week, it still generated a “red candle” using the Heikin Ashi bars.  This is because the Heikin Ashi candles are focused on average price movements.  As such, despite a positive price week for the S&P 500 Index, the Heikin Ashi candles indicate that the price trend is still lower.

Additionally, note that typically before a reversal in price, the Heikin Ashi price bars will indicate this by having an “upper wick” or “upper shadow” the week or two prior to the reversal taking place.  I have noted how this has played out in the past using the black arrows.  This last week did not register a “upper wick/shadow” thus further suggesting that the trend is lower.

heikin ashi technical analysis colquitt

Powell Visits Capital Hill

Jerome Powell will testify to Congress today and Thursday. Likely, Powell will focus on the Fed’s plan to tackle inflation. Therefore to better prepare for the potential of volatile trading, the graph below from Brent Donnely sheds light on instances where Powell has been less hawkish.

Per Brent: Jerome Powell doesn’t know any more than you do about where the economy is headed. That’s why I have emphasized that markets should trade the data, not Powell. Here is the performance of equities around three big dovish Powell moments. The red bar is the day Powell spoke.

jerome powell trading

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Bear Trap? Market Holds Critical

Is the recent correction a “bear trap?” Or is the bounce just a selling opportunity for a return of the bear market?

A bear trap occurs when there is a bearish correction or reversal amid an overall uptrend. A downward correction sees shorting temporarily overcoming buying pressure, leading to a short-term price fall. The decline may be small or large, potentially failing at recent price highs in the uptrend.

The downward correction may last several trading sessions, giving a false impression that the market has indeed reversed. Traders might take short positions to profit on falling stock prices, but when buyers begin seeing prices drop and increase their buying activity, the market won’t support prices falling further. It then rapidly resumes its uptrend.” – Investopedia

Such will be the center of the debate after the recent market correction that tested support at the 200-DMA. However, as we discussed at the beginning of February, a correction was needed if the bull market was going to continue. To wit:

“If the “bear market” is “canceled,” we will know relatively soon. To confirm whether the breakout is sustainable, thereby canceling the bear market, a pullback to the previous downtrend line that holds is crucial. Such a correction would accomplish several things, from working off the overbought conditions, turning previous resistance into support, and reloading market shorts to support a move higher. The final piece of the puzzle, if the pullback to support holds, will be a break above the highs of this past week, confirming the next leg higher. Such would put 4300-4400 as a target in place.”

Such is precisely what happened with the market testing, and holding, the rising trend channel from the October lows. The market also held the 200-DMA, which, as noted, confirmed the bullish breakout above a level that proved to be resistance in 2022.

Market technicals with trend channel

Furthermore, as discussed in the past weekend’s newsletter, the MACD “sell signal” is close to reversing to a buy signal.

“Importantly the MACD ‘sell signal,’ which warned of the recent correction, is beginning to reverse. However, that reversal occurs midway through regular oscillation, suggesting that the upside is somewhat limited.”

The chart below is longer-term than what we showed in the newsletter but better indicates the validity of the “sell signal.” The “buy signals” were also good opportunities to trade rallies during last year’s decline.

S&P 500 vs Moving Averages

While there are certainly many fundamental reasons to remain “bearish” on the markets, The technical backdrop continues to confirm and reaffirm a more bullish trend developing.

If this is a “bear trap,” then Jim Cramer may be correct when he says:

“If we’re in a bull market, and I think we are, you have to prepare yourself,” he said, adding, “We have to prepare for the down days now because in a bull market, they’re buying opportunities.” – CNBC

While the short-term technicals are bullish, the longer-term technicals also remain bullishly biased.

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Long-Term Technicals Remain Bullish

Daily price charts can provide a short-term view of market psychology from days to weeks. The problem with daily price analysis is volatility can cause short-term swings in the market that can disconnect from the market’s underlying trend or fundamental data.

If we slow that price action by examining weekly pricing data, the volatility gets smoothed out. Such reveals a clearer picture of the market delivering a more bullish message.

The S&P 500 has scored seven weekly closes above its 40-week moving average, which is a positive sign. In addition, the market has cleared the 40-week DMA downtrend line from January and December 2022, suggesting a potential bullish turn in the trend. Assuming supports hold, the next major resistance beyond the post-FOMC peak at 4195 is the August 2022 peak at 4325 (orange dashed line).

S&P 500 vs weekly moving averages since 2019

Furthermore, the October low held support at the 200-week moving average, which remains support for the market since the 2009 lows.

S&P 500 vs weekly moving averages since 1999

The weekly 14-period relative strength index (RSI) has also turned sharply positive and is above 50, suggesting markets are back in a bullish trend. That index broke above resistances that capped bear market rallies in April, August, and December 2022.

S&P 500 weekly moving averages versus RSI

Lastly, our most critical bullish signals are the short- and intermediate-term Moving Average Convergence Divergence (MACD) indicators. We post this weekly chart in our website’s 401k plan management section. Both sets of weekly MACD indicators have registered buy signals from levels lower than during the financial crisis. The market has also broken above both weekly moving averages and, as noted above, held the long-term bullish trend line.

S&P 500 vs weekly moving averages vs MACD
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Bull Now, Bear Later

Given the abundance of bullish signals, we must give some credence to the message and invest accordingly. However, ample fundamental evidence supports the argument that the “bear market” is not yet dead.

The markets have grown “manic,” quickly swinging wildly from extreme pessimism to optimism. Such is not the basis on which investing activity resides but rather where speculation abounds in its purest form.

Over the next 12 months, the “bear market is over” thesis will depend much on the Federal Reserve, Government policies, and inflation. The recent passage of the “Inflation Reduction Act” will increase taxes on corporations and households. Such will reduce growth and profit margins along with stubbornly high inflation. Furthermore, the surge in the money supply will continue to reverse, reducing earnings growth rates further.

GAAP earnings vs M2

Of course, tighter monetary from the Federal Reserve is weighing on economic growth, which will continue later into the year, with a recession become more likely with each rate hike. Notably, there is a high correlation between economic growth and earnings.

GAAP earnings vs GDP

Such is an important backdrop. The markets are pricing earnings of roughly $199 per share by the end of 2023, down from $242 in July. However, if the Fed continues its fight against inflation and triggers a recession, earnings could drop to $170/share. At a generous forward multiple of 18x those earnings, you are looking at a fair market calculation closer to 3000 on the S&P 500 index.

S&P 500 Earnings estimates.
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While the technicals suggest this is a “bear trap,” the fundamentals do not support that argument. When it comes to equity risk, it is corporate earnings that will drive equity prices. As the Fed hikes rates to slow economic activity and potentially cause a recession, such will translate into slower earnings growth and reduced profit margins. Given that valuations are near 29x earnings currently, such suggests that stocks must reprice lower. The 6-month annual rate of change of the Leading Economic Index (LEI) supports that thesis, meaning earnings will decline over the next two quarters.

LEI 6-mongh ROC vs Earnings

Whether the bull or bear trap view wins will only become known in time. However, as noted, while the bulls currently control the technical picture, the Fed still has control of the macro environment. While we will continue to trade the markets tactically in the short term, in our view, there is still a risk of a more profound decline unless the Fed changes course in short order.

We must wait and see who wins the “bull market is over” debate.

From Consumer Sentiment To Unemployment – The Parallels

On Friday, February 24th, the most recent reading of the University of Michigan Consumer Sentiment Index was released. It came in at 67.0 for February, an increase from January’s reading of 64.9.

As the name implies, the University of Michigan Consumer Sentiment Index measures consumer “sentiment” in the United States. Higher numbers suggest a more positive sentiment; lower numbers indicate a more pessimistic view. 

Investopedia notes the following regarding the University of Michigan Consumer Sentiment Index:

“Consumer sentiment is a statistical measurement of the overall health of the economy as determined by consumer opinion. It takes into account people’s feelings toward their current financial health, the health of the economy in the short term, and the prospects for longer-term economic growth, and is widely considered to be a useful economic indicator.”

The chart below shows the University of Michigan Consumer Sentiment Index and the Unemployment Rate from the 1980s (Note: the red vertical bars denote US recessionary periods). 

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Two Observations

There are two observations to take away from this data.

  1. Both metrics trend over time, but the University of Michigan Consumer Sentiment Index appears to be extremely noisy in the process.
  2. There appears to be a negative correlation (i.e., when one goes up, the other one goes down) between the two metrics.
Consumer confidence index vs Unemployment

To strip out some of the “noise” in the chart below, I am displaying the 24-month moving average for the University of Michigan Consumer Sentiment Index (blue line). Additionally, I have inverted the University of Michigan Consumer Sentiment Index values to observe if the two metrics are negatively correlated.

When we do this, we find that while not a perfect match, they tend to track one another quite nicely.

Consumer sentiment index vs unemployment 2nd chart.

Because the two metrics tend to move in tandem with one another, this would suggest they are “coincident.” However, there are a few observations (green arrows in the chart below) where the University of Michigan Consumer Sentiment Index appears to be a “leading” indicator for the Unemployment Rate.

Consumer confidence index vs unemployment 3rd chart

Another Way To Analyze The Data

Looking at the most recent green arrow in the chart above…is the University of Michigan Consumer Sentiment Index suggesting that the Unemployment Rate is about to start trending higher?

The chart below shows a scatter plot of the values from the previous graphs. The downward-sloping red line suggests a negative correlation between the two metrics.

Consumer sentiment index vs unemployment scatter plot.

Another note from the chart above is that there appear to be two periods with outlying observations, which I’ve highlighted in the chart below. 

Consumer sentiment index vs unemployment scatter plot. 2nd chart.

If we dive deeper into the origin of these anomalies, we find that one likely caused the other, which is often the case when we see the pendulum swing from one extreme to another. 

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Why Is This Important?

The first “distortion” results from the period immediately following the beginning of Covid, where the Unemployment Rate spiked, yet we didn’t see a massive drop-off in consumer sentiment. 

Fast forward, and we see the pendulum swing in the opposite direction, as evidenced by the last 16 months. During this time, we’ve witnessed record-low levels of unemployment even though “sentiment” in the US economy has begun to sour. 

It’s common to see dramatic swings like this from one extreme to another until the market returns to equilibrium.   

We get the scatter plot below if we strip out these two outlier periods. Note that this scatter plot has an r-squared value of 0.6931 which is statistically very strong, thus suggesting a reasonably tight relationship between these two metrics. 

The current value for the University of Michigan Consumer Sentiment Index – 24 Month Moving Average (67.3) suggests that the current Unemployment Rate should be between 7.0% and 10.0%. 

Consumer sentiment index vs unemployment scatter plot. 3rd chart.

In my piece, Layoffs…What Are They Telling Us? I made the case that even the FOMC believes that the Unemployment Rate will increase, as they foreshadowed in their “Summary of Economic Projections” released in December.

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How High Will The Unemployment Rate Go? 

I don’t know how high the unemployment rate will go. However, as noted above, the current reading for the University of Michigan Consumer Sentiment Index – 24 Month Moving Average would suggest that the Unemployment Rate should be somewhere in the 7.0% – 10.0% range. 

Alternatively, what if, in the coming months, we see a dramatic improvement in the University of Michigan Consumer Sentiment Index – 24 Month Moving Average, somewhere directionally towards its long-term average of ~86? You can see from the chart above that a value of 86 has historically corresponded to an unemployment rate of 5.0% – 7.0%.

Given that the Unemployment Rate is currently 3.4%, the University of Michigan Consumer Sentiment Index would suggest it “needs” to go higher. Is it going to 7.0% – 10.0%? I certainly hope not, but the high end for the FOMC’s range of outcomes for 2023 is 5.3%, so maybe the 5.0% – 7.0% range is at least within the realm of possibilities. 

As noted in “Layoffs…What Are They Telling Us?”:

Since the 1950’s, every time the unemployment rate had a sustained increase above its 12-month moving average, a recession has occurred.”

I followed by saying:

“The current unemployment rate is 3.4% and the current 12-month moving average is 3.59%.  If the FOMC is even directionally correct in their assessment of where the unemployment rate is heading in 2023, and subsequent years, the unemployment rate will easily cross above its 12-month moving average and will likely be sustained there for a period of time.”

Not to be draconian, but the takeaway is that we’re heading for a recession, and the University of Michigan Consumer Sentiment Index gives you advanced notice.

The question then becomes, “What should I do with this information?”. 

I would remind you of this historical fact:

If we look at history, we find that since the 1960’s, the S&P 500 has always made a new low once a recession began and the average decline from the start of a recession to the market trough is -29.2%.  Further, if we look at this same time period, we find that the average decline from the first FOMC rate cut to the market trough is -27.7%.”

It’s not too late to prepare for this potential outcome. 

Until next time…

Rent Burden, An Economic Tax

Per a recent Yahoo article: “The average American renter is now paying more than 30 percent of their income on housing, as wages have failed to keep up with rent hikes and affordable units remain scarce, a new report shows.” The government defines those with a rent burden as paying more than 30% of their income on rent. The article further estimates over 40% of low and middle-income citizens are rent burdened. Higher interest rates and low supply are to blame Per Yahoo, “High mortgage rates compound the problem, as those who want to transition to homeownership are locked out of that market, said Nicole Bachaud, a senior economist at Zillow.” From a macroeconomic stance, consider that those with more money allocated to rent have less to contribute to the economy. Like higher interest rates, higher rents also burden the economy.

Fortunately, rental prices have started declining, hopefully easing the growing rent burden in the coming months. We wrote in a recent Commentary that OER will continue to decline. To wit: “the OER price index is over 10% above its 35-year trend line. Therefore we believe the recent increase is an anomaly that will correct as the supply-demand equation normalizes quickly this year.” OER refers to owners’ equivalent rent, the BLS’s rent-based measure to calculate CPI.

rent burden

What To Watch Today


  • Factory Orders, January



Market Trading Update

Last week, we stated that the worse-than-expected data on inflation and hawkish Fed minutes sent markets reeling and took out support at the 50-DMA.

“Critical support at the rising trend line from the October lows and the 200-DMA is now getting tested. A failure of those levels next week will put the bears back in charge of the market near term.”

Fortunately, the bulls stepped in on Thursday and Friday to rally the markets off that 200-DMA support, keeping the rising trend intact. However, the rally is now challenging existing resistance at the 20-DMA, but the previous highs around 4200 are the most logical target currently. Importantly the MACD “sell signal,” which warned of the recent correction, is beginning to reverse. However, that reversal occurs midway through normal oscillation, suggesting that the upside is somewhat limited.

Market Trading Update

While the MACD signal starts to turn, it can fail when our MoneyFlow indicator does not confirm the turn. Such is the case currently, but next week’s action will provide a more definitive outlook. The MoneyFlow indicator is near its cycle lows, similar to what we saw when the MACD turned positive at the December lows.

MioneyFlow Indicator

As such, we recommend selling any rally next week approaching the 4200, which is now important resistance.

Notably, the market remains confined to a rising trend channel, so we must respect that price action until it changes. That channel suggests the markets could rally as high as 4350 over the coming months, which remains in line with the seasonally strong period. However, if that channel is broken, there is roughly an equal amount of downside. In other words, the reward versus the risk from current levels is not great.

The Week Ahead

Labor headlines dominate this week’s economic reports. ADP and JOLTs on Wednesday, Jobless Claims Thursday, and the BLS labor report on Friday will better inform the Fed on the current state of the labor market. Payrolls are expected to grow by 210k, and the unemployment rate is expected to remain stable at 3.4%, a fifty-year low. Outside of the labor market, this is little other economic data. Investors will likely shift focus to the CPI report due next Tuesday.

Fed members will likely remain vocal this week as they head into their media blackout period starting next week as they approach the March 22 FOMC meeting.

The Mortgage Dilemma

The following graph shows that about 75% of mortgages have an interest rate of 4% or below. As a result, many of these homeowners seeking a new job, or those wishing to upsize or downsize will find higher mortgage rates a considerable impediment. We present the following example to show how high mortgage rates limit supply and demand in the housing market and keep the labor market tighter than it should be.

Assume a homeowner has a 3.50% mortgage on a $500,000 house. Their monthly payment is $2,245, excluding taxes and insurance. To incur the same monthly mortgage payment at current mortgage rates, the homeowner can only afford a house worth $335,000. Even if they put $100,000 down, making it a $400,000 mortgage, the monthly payment would still increase by roughly $400. The demand for housing will weaken as a result. Further, the labor market will remain tight as employees may be unable to move for a new job.

mortgage rate distribution

Silvergate Bank is on the Ropes

Silvergate Capital Corp, deemed banker to the crypto world (SI), fell 60% on Thursday to just under $6 a share. Silvergate’s fall from grace has been stunning in just over a year. Consider SI traded near $240 to close out 2021. Silvergate is a crypto-friendly bank with ties to FTX and other crypto firms either embroiled in fraud or near bankruptcy, as we share in the second graphic.

Driving Thursday’s sharp decline, the company could not file its SEC 10-K annual report for 2022 on time, nor will it meet the extended deadline in mid-March. Further, the bank said it was not sure it would survive as a “going concern.” Per its Notification of Late Filing:

These additional losses will negatively impact the regulatory capital ratios of the Company and the Company’s wholly owned subsidiary, Silvergate Bank (the “Bank”), and could result in the Company and the Bank being less than well-capitalized. In addition, the Company is evaluating the impact that these subsequent events have on its ability to continue as a going concern for the twelve months following the issuance of its financial statements.

The rumor is that the FDIC will seize SI’s assets and let Wells Fargo take over the customer accounts. The FDIC will bear any losses if the company fails. Silvergate is not large enough to dent the FDIC’s war chest, but its failure will likely bring significant political pressure to regulate the industry.

silvergate stock
silvergate affiliations

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ISM Survey Avoids Sounding the Recession Alarm

The graph below shows that a sub-45 reading on the ISM manufacturing survey index has accompanied nine of the last ten recessions. The only outlier, and by a very slim margin, was 2020. The never-seen-before economic shutdown and the massive stimulus made that recession non-comparable to more typical economic slowdowns.

The latest ISM survey rose slightly from 47.4 to 47.7, staying above 45. A reading below 50 denotes economic contraction. New orders, a good leading indicator, rose to 47 from recent lows of 43, but it remains in contraction territory. Employment fell slightly, but the prices paid index rose sharply to 51.3 from 44.5. It signals that inflationary pressures remain. The ISM survey data point to the Fed’s conundrum. Economic indicators like ISM are dangerously close to signaling a coming recession, yet price pressures remain high.

ism and recessions

What To Watch Today


  • S&P Global U.S. Services PMI, February Final (50.5 prior)
  • S&P Global U.S. Services Composite PMI, February Final (50.2 prior)
  • ISM Services Index, February (54.5 expected, 55.2 prior)


  • No notable earnings releases today

Market Trading Update

Finally, a rally. As noted, we were looking for a rally this week as the market is very oversold. While there were several attempts to rally, they all failed until yesterday’s test of the 200-DMA, which brought buyers in looking for the “dip.” While the bounce was welcome and a good first retest of support, it was not a strong bullish advance. The conviction of buyers was missing suggesting any follow-through may be limited for now. There are a lot of “trapped longs” in the market currently, which will likely use rallies over the next couple of weeks to sell into. Such will keep any advance limited.

Continue using rallies to the 20-dma to reduce risk, raise cash, and rebalance portfolios accordingly. While the market has not done anything “Technically” wrong since the October lows, the downside risk is present. Continue to protect capital until a more bullish setup is in place.

Market Trading Update

Productivity and Labor Costs

Fourth quarter productivity was revised sharply lower from 3% to 1.7%. The culprit was an upward revision to unit labor costs from 1.1% to 3.2%. The data indicates corporate margins may be under pressure due to sharply rising wages. The graph below from John Hussman shows the correlation between labor costs and profit margins.

While the information is from the fourth quarter, it is not welcome news for the Fed, which fears a price wage spiral. It also points to a resilient economy where companies may be desperate for employees even at higher costs and reductions in productivity.

The graph below shows that annualized unit labor costs and the employment cost index are double their pre-pandemic run rate.

unit labor costs

Post Pivot Divergences

Throughout 2022 Stocks and bonds traded in lockstep with the Fed’s plan for rate hikes. In October, stocks rallied, and bond yields fell as it was widely believed the Fed was nearing the end of their rate hikes, and a pivot to lower rates in the second half of 2023 was likely. Recently, substantial employment growth, good economic data, and higher-than-expected inflation data have quashed the pivot narrative.

The table below looks at various markets to see how they are digesting the new line of Fed thinking. For starters, Fed Fund futures are up over 1% and pricing in 5.40% Fed Funds by year-end. Treasury bills followed, up almost 1% since October. Ten-year Treasury notes and five-year inflation expectations are up slightly. Both are for extended periods, so the market is pricing in higher short-term rates and, simultaneously, the negative effect of higher short-term rates on longer-term economic activity and inflation.

Lastly, the S&P 500 has declined recently but is still about 10% above last October’s price, despite sharply higher expectations for Fed Funds. Can bond and stock investors have significantly different views on what the Fed will do? Such is not often the case, but maybe this time will be different.

performance since the pivot

Upside Down Cars

Higher new and used car prices and longer auto loan terms result in some car owners being underwater. In other words, the value of their car is worth less than their loan amount. If trading the vehicle in, they need to make up that difference which takes away from their ability to buy a new car. The Bloomberg graph below shows that the average amount of negative equity of the vehicles with negative equity being traded in is rising. While below the pandemic peak, it is above the pre-pandemic peak of $5,000 and rising. Below the graph are a few facts on the auto market from Edmunds.

upside down drivers negative equtiy

Per Edmunds:

  • The average annual percentage rate (APR) on new financed vehicles climbed to 6.5% in Q4 2022 compared to 5.7% in Q3 2022 and 4.1% in Q4 2021. The APR on used financed cars climbed to 10% in Q4 2022 compared to 9% in Q3 2022 and 7.4% in Q4 2021.
  • 15.7% of consumers who financed a new vehicle in Q4 2022 committed to a monthly payment of $1,000 or more — the highest it’s ever been — compared to 10.5% in Q4 2021 and 6.7% in Q4 2020.
  • 17.4% of new vehicle sales with a trade-in had negative equity in Q4 2022, compared to 14.9% in Q4 2021.
  • The average amount owed on upside-down loans was $5,341 in Q4 2022 compared to $4,141 in Q4 2021.

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Gen Zers Are Overly Optimistic About Being Wealthy

Gen Zers, according to a recent Magnify Money survey, are overly optimistic about being wealthy. In fact, according to the survey, they are THE most financially optimistic generation. To wit:

Nearly three-quarters (72%) of Gen Zers believe they’ll become wealthy one day, making them the most financially optimistic generation.”

But, interestingly, that optimism, as noted by the firm’s executive editor, is “more than just youthful optimism.”

“We are surrounded by extremes of wealth and poverty, and I think younger folks naturally gravitate to the more positive extremes. What’s more, the concept of investing is so much more accessible today, and I know many Gen Zers believe they can harness the power of the market to build wealth.” – Ismat Mangla

Interestingly, Gen Zers are optimistic they can use the stock market to build wealth. Unfortunately, that hasn’t worked out well for the generations before them.

Since 1980, there have been three major bull market cycles. The first started in the mid-80s and culminated in the bust at the turn of the century. The early 2000s saw the inflation of the “real estate” bubble heading into the 2008 “financial crisis. We live in the third “everything bubble” fueled by a decade-long push of monetary and fiscal interventions.

However, 80% of Americans are still not “wealthy after these three major bull markets.”

That is according to some of the most recent surveys and Government statistics:

  • 49% of adults ages 55 to 66 had no personal retirement savings, according to the U.S. Census Bureau’s Survey of Income and Program Participation (SIPP).
  • The latest Federal Reserve Survey of Consumer Finances found that the median savings in Americans’ retirement accounts were $65,000.
  • Less than half of those surveyed saved $100,000. Not enough to support a median retirement income of around $40,000 a year
  • One in six say they have saved nothing. A third currently makes NO contributions. 
  •  80% of people expected to see their living standards fall in retirement. 10% feared they wouldn’t be able to retire at all.

Will it be different for Gen Zers in the future? Unfortunately, it likely won’t be for the same reasons that using the stock market to build wealth didn’t work for the generations before them.

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80% Of Americans Aren’t Wealthy

According to the Magnify survey, Gen Zers defined “being wealthy” by several measures:

Chart showing how Americans define the term 'wealthy.'

Most surveyed define “wealthy” as living comfortably without concern about their finances. As shown below, that goal has eluded all but the top 20% of income earners.

Graph showing inflation adjusted household net worth by brackets.

While 72% of Gen Zers believe they will be wealthy, the net worth of the bottom 50% of Americans has remained relatively unchanged since 1990. While the middle 50-90% of Americans have seen an increase in net worth, it has not been enough to keep up with the “standard of living,” which, as discussed previously, continues to push Americans further into debt.

“The current gap between savings, income, and the cost of living is running at the highest annual deficit on record. It currently requires roughly $6,300 a year in additional debt to maintain the current standard of living. Either that or spending gets reduced which is the likely outcome as a recession becomes more visible.” – The One Chart To Ignore

Graph showing consumers failing to make ends meet from 1959 to 2019.

Another Magnify Money survey supports this bit of analysis by showing that roughly 50% of working Americans live “paycheck-to-paycheck,” meaning they have no money left after expenses. While that was common among those making less than $35,000 annually (76%), 31% of those making more than $100,000 experienced the same.

The critical point is that it is hard to count on the stock market to build wealth when you don’t have excess savings with which to invest.

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The Stock Market Won’t Make You Wealthy

Generation Z, born between 1992 and 2002, was between 5 and 16 years old during the financial crisis. Such is important because they have never truly experienced a “bear market.” Any advice they might have received from financial advisors suggesting caution, asset allocation, or risk management was repeatedly proven to underperform the market.

“Ha….Boomers just don’t get it.”

However, since they became old enough to open an investment account, they have only seen a “liquidity-driven” bull market that fostered a generation of “Buy The F***ing Dip “ers.

Graph showing generation z's stock market from 2014 to 2022.

However, while the lack of savings was one of the key points in “The One Chart To Ignore,” the other key point, and why 80% of Americans didn’t build wealth, is that “markets don’t compound returns.

There is a significant difference between the AVERAGE and ACTUAL  returns received. As I showed previously, the impact of losses destroys the annualized ‘compounding’ effect of money. (The purple shaded area shows the “average” return of 7% annually. However, the differential between the promised and “actual return” is the return gap.)

Hodl, “HODL” Finds Its Inevitable Flaw

While 26% of Gen Zers think that investing in the stock market and 19% in Cryptocurrencies will be their ticket to financial wealth, a lot of financial history suggests this will not be the case.

Bar chart showing strategies Americans are using to build wealth (by generation).

While Gen Zers are very optimistic they will be wealthy in the future, a mountain of statistical and financial evidence argues to the contrary. Will some Gen Zers attain a high level of wealth? Absolutely. Roughly 10% of them. The remainder will likely follow the exact statistical breakdown of the generations before them.

The reasons for that disappointing outcome remain the same. If investing money worked as the mainstream media suggests, as noted above, then why, after three of the most significant bull markets in history, are 80% of Americans so woefully unprepared for retirement?

The crucial point to understand when investing money is this: the financial market will do one of two things to your financial future.

  1. If you treat the financial markets as a tool to adjust your current savings for inflation over time, the markets will KEEP you wealthy. 
  2. However, if you try and use the markets to MAKE you wealthy, the market will shift your capital to those in the first category.

Experience tends to be a brutal teacher, but it is only through experience that we learn how to build wealth successfully over the long term.

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How Money Really Works

It isn’t just about investing money. There are also vital points about the money itself.

1. Your career provides your wealth.

You most likely will make far more money from your business or profession than from your investments. Only very rarely does someone make a large fortune from investments, and it is generally those that have a business investing wealth for others for a fee or participation. (This even includes Warren Buffett.)

Focus on your career, or business, as the generator of your wealth.

2. Save money. A lot of it.

“Live on less than you make and save the rest.” Such sounds simple enough but is exceedingly difficult in reality. Given that 80% of Americans have less than $500 in savings tells the real story. However, without savings, we can’t invest to grow our savings into future wealth.

3. The true goal of investing money is to adjust savings for inflation.

As investors we get swept up into the “casino” called the stock market. However, the true goal of investing is to ensure that our “savings” adjust for future purchasing power parity in the future. While $1 million sounds like a lot today, in 30-years it will be worth far less due to the impact of inflation. Our true goal of investing is NOT to beat some random benchmark index by taking on excess risk. Rather, our true benchmark is the rate of inflation.

4. Don’t assume you can replace your wealth.

The fact that you earned what you have doesn’t mean that you could earn it again if you lost it. Treat what you have as though you could never earn it again. Never, take chances with your wealth on the assumption that you could get it back.

5. Don’t use leverage.

When someone goes completely broke, it’s almost always because they used borrowed money. Using margin accounts, or mortgages (for other than your home), puts you at risk of being wiped out during a forced liquidation. If you handle all your investments on a cash basis, it’s virtually impossible to lose everything—no matter what might happen in the world—especially if you follow the other rules given here.

6. Whenever you’re in doubt, it is always better to err on the side of safety.

If you pass up an opportunity to increase your fortune, another one will be along soon enough. But if you lose your life savings just once, you might never get a chance to replace it. Always err on the side of caution. Always ask the question of what CAN go “wrong” rather than focusing on what you “HOPE” will go right.

Investing money in our future is not as simple as much of the media makes it seem. We all want to be able to under-save today for tomorrow’s needs by hoping the markets will make up the difference. Unfortunately, there is no magic trick to building wealth.

The process of saving diligently, investing conservatively, and managing expectations will build wealth over time.

It’s boring. But it works.

No matter your age, it’s not too late to start making better choices.

Home Purchase Index Drops to 25+ Year Low

Wednesday’s Home Purchase Index fell sharply to the lowest level since 1995. The index compiled by the Mortgage Bankers Association (MBA) computes the number of home purchases based on a sample of approximately 75% activity. The combination of elevated home prices and mortgage rates approaching 7% keeps individuals from buying houses or even seeking out mortgage applications. The MBA mortgage application index is also near 28-year lows.

The most recent Case-Shiller Home Price Index has fallen but still stands almost 20% above trend. In addition to high prices, mortgage rates keep the affordability of homes out of range for many potential buyers. While the demand side of the housing market is troubling, owners aren’t selling. The supply of existing homes is under three months. Compare that to the relatively hot housing market in the five years pre-pandemic when the supply was never below three months! The chart below of the MBA home purchase index is courtesy of Mish Shedlock.

mba mortgage purchase index home

What To Watch Today


  • 8:30 a.m. ET: Q4 Nonfarm Productivity (est. 2.5%)
  • 8:30 a.m. ET: Q4 Unit Labor Costs (est. 1.6%)
  • 8:30 a.m. ET: Weekly Initial Jobless Claims (est. 195,000)
  • 8:30 a.m. ET: Weekly Continuing Jobless Claims (est. 1,669,000)



Market Trading Update

It’s make-or-break time for the S&P 500 as the market closed on the 200-DMA yesterday, coinciding with the top of the downtrend line from the January 2022 peak. With the market now oversold on a short-term basis, following two weeks of steady selling pressure, a rally today or tomorrow will not be surprising.

Here is the important point. If the market breaks support at the 200-DMA, it is advisable NOT to sell down exposure immediately. The reason is that there has been a lot of selling pressure by the time the market breaks a support level. With sellers likely exhausted short-term, we often see initial breaks of support retraced in the next couple of days. Be patient, and wait for a bounce to see if the broken support is retaken or a failed test. If the market rallies to previous support and fails, it will be a confirmed break, and equity risk can be reduced. This lag will help reduce potential “head fakes” that sometimes occur with technical analysis.

Market Trading update

Volatility in Bull and Bear Markets

The graph below from Willie Delwiche compares the S&P 500 (blue) to the number of consecutive days (orange) in which the S&P 500 moved less than 1%. The graph is an excellent way of showing that volatility in bull markets tends to run much lower than in bear markets. Since 2022, the longest streak of days in which the market did not move more than 1% daily was seven. Most often since 2022, two to three days of low volatility was a long streak. The second graph below is from an upcoming article on risk and return. It shows significantly more instances of larger daily price moves in bear markets than in bull markets.

bull and bear market returns volatility
bull and bear market volatility returns

China is Reopening To Powell’s Chagrin

China dropped its strict covid protocols this year, and the economy seems to be waking up. The PMI index, which tends to lead economic growth, rose to 52.6, the highest reading since 2012. The graph below shows that the output and new orders part of the PMI index jumped to a 13-year high. Non-manufacturing showed equally strong gains. While we should cheer such strong growth from the world’s second-largest economy, we must also consider China’s reopening will put upward pressure on inflation. Commodities are trading higher on the news while inflation expectations are ticking up. This bit of information will reinforce the Fed’s hawkish stance.

china pmi inflation recession

How Valid is the No Landing Scenario?

During most of 2022, economists on Wall Street and the Fed debated how the economy would slow. Some, like Powell, believed a soft landing with no recession was possible. Others felt a hard landing, aka recession, would likely result from higher interest rates. Recently, the no-landing scenario has been growing in popularity. For more on this theory, check out our latest article, The No Landing Scenario and UFOs.

To forecast such a scenario, you must believe this time is different. The article describes how the economy is MORE vulnerable to higher interest rates, not LESS vulnerable. Further, we provide multiple charts showing various leading indicators often preceding recessions. We share a few below. Is this time different?

yield curves recession no landing
oecd leading indicators recession no landing
ism recession no landing

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Staples or Discretionary Stocks?

Consumer staple companies typically include companies that sell essential goods. As such, earnings growth tends to be limited but reliable, even during a recession. Proctor Gamble, the maker of many household items we use daily, is the most significant contributor to the sector. Conversely, discretionary stocks sell non-essential goods. Amazon and Tesla make up a third of the sector. Discretionary stocks have more earnings volatility than staples. Earnings volatility tends to translate into stock price volatility.

In last year’s downward trend, staples outperformed discretionary stocks. Lower betas and valuations, along with steady earnings, proved to benefit staples. The graph below shows the strong correlation between the staples to discretionary stocks ratio and the VIX volatility index. The chart affirms what we witnessed. Periods of higher volatility, often accompanying market drawdowns, saw staples outperform.

staples vs discretionary vs volatility

What To Watch Today


  • MBA Mortgage Applications, week ended Feb. 24 (-13.3% prior)
  • S&P Global U.S. Manufacturing PMI, February Final (47.8 prior)
  • Construction Spending, month-over-month, January (0.4% expected, -0.4% prior)
  • ISM Manufacturing, February (47.9 expected, 47.4 prior)
  • ISM Prices Paid, February (44.5 prior)
  • ISM Employment, February (50.6 prior)
  • ISM New Orders, February (42.5 prior)
  • Wards Total Vehicle Sales, February (15.00 million, 15.74 million prior)



Market Trading Update

Yesterday morning, I posted the following tweet:

Here is a larger version of that chart.

Market trading update 1

Yesterday was disappointing, again, with the market opening higher and selling into the close. However, the good news is that the market continues to cling to support at the 50-DMA and the uptrend line. However, yesterday’s decline is eating into the very small “margin of error” the market currently maintains between a “bull market” and a “bull trap.”

Market trading update 2

Overall, trading remains tepid, which is dangerous in a corrective market, as a break of support will likely bring program sellers into the market all at once. That critical level is the 200-DMA, where most programmed sell orders are currently stacked up.

Remain cautious and use modest advances to reduce equity risk and rebalance portfolios.

The Leverage Tax

The calls for a soft landing and no landing by many “esteemed” economists are startling, given the enormous headwinds in higher interest rates. The graph below shows the ratio of the amount of debt versus the ability to pay for the debt (GDP) has skyrocketed in many countries, including the U.S. The U.S. ratio was about 1:1 before the 2008 financial crisis. In only 15 years, it has doubled. Simply, the economy is more leveraged. Therefore, economic activity is also much more sensitive to interest rates.

Interest rates are now at or above levels seen in 2008. The tax on leverage, via higher interest rates, is coming due. As companies, individuals, and the government refinance maturing debt or issue new debt, their interest expenses will increase markedly. To compensate for the higher rates, consumers will spend less. Corporations will find ways to cut costs, including laying off employees. Lastly, the government may limit spending to keep the deficit somewhat contained. Bottom line- more money will be spent on debt servicing, leaving less for economic growth. This matters when sustainable economic growth is sub 2%.

leverage debt to gdp

Trimmed Mean Inflation Worries the Fed

The Fed likes to slice and dice inflation data to understand its intricacies. The chart below, for example, shows two closely followed Fed inflation measures that the public often overlooks. The Dallas and Cleveland Feds put out Trimmed Mean inflation measures. They compute the average after stripping out the highest and lowest price changes. The figures attempt to show the price changes for the bulk of goods. As we share below, both gauges show the prices for most goods are not falling nearly as much as CPI and PCE.

inflation, prices  trimmed mean fed

Another Confounding Look at Credit Spreads

In Corporate Bonds Have No Recession Fears, we discussed how corporate credit spreads versus Treasuries were below average despite the growing possibility of a recession. To wit: “The term “picking up pennies in front of a steam roller “comes to mind when looking at the graph below.”

Further to the conversation, consider the graph below. As it shows, the high-yield bond index and credit standards tend to be well correlated. Currently, the correlation has broken down. The risk is that yields catch up to credit standards, as is the norm.

credit spreads financial conditions

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The No Landing Scenario and UFOs

As if the 2020s haven’t been strange enough, the United States military recently shot down several UFOs. Equally bizarre as the possibility of aliens, some investment analysts are projecting an economic no landing scenario. They believe economic activity will easily absorb significant headwinds and chug along.

The last few years have been humbling for economists, the Fed, and investment professionals. In late 2021 no one expected the Fed would raise rates by over 4% within a year and inflation would approach levels last seen 40 years ago. In hindsight, had we or any economist foreseen the future, a recession prediction would have been appropriate. Such has yet to happen, but that doesn’t mean a recession won’t happen. Unfortunately, current monetary policy all but ensures the economic cycle will play out as it always does.

While the economy may seem unpredictable, the economic future is predictable. The no landing scenario assumes economic cycles have ceased to exist. The economic cycle is alive and well. But timing its ups and downs with unprecedented amounts of fiscal and monetary stimulus still flowing through the economy and markets is proving incredibly challenging. 

What is a No Landing Scenario

Unlike a soft landing that envisions the Fed action’s dampening economic growth, the no landing scenario believes the economy will continue to grow at or above the trend growth rate. Such optimism assumes that the Fed’s restrictive monetary policy will not cause the economy to stumble.

GDP, as graphed below, in dollar terms (orange line), paints the picture of an economy constantly growing and essentially free of cycles. However, viewing annual growth rates (blue line) and the trend (dotted blue line), we find that GDP cycles regularly, and the growth trend is steadily declining. To forecast a no landing means you believe the blue GDP growth rate line will flatten and stay linear.

That did occur, to a degree, following the financial crisis (2010-2018), but the Fed pegged interest rates to zero and resorted to multiple rounds of QE at the first sign of trouble. The monetary conditions during that no landing period versus the current period are polar opposites. 

real gdp trend cycles soft landing
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What Drives the Economy?

The economy’s trend growth rate is around 2.0%, well below the rates of prior decades. The Fed predicts the long-run growth rate (beyond 2025) to be 1.8%.

Growth is and has been declining for decades. The two leading factors supporting economic activity, productivity, and demographics, contribute less and less each year to economic activity.

In Capital Neglect is Killing Capitalism, we elaborated on the importance of productivity growth and how the Fed’s aggressive monetary policy in years past has stifled productivity growth.

Not surprisingly, GDP growth followed the declining path of productivity growth. As we share below, it’s possible GDP could run much higher if the pre-1970 productivity trends continued. 

tfp economy gdp trends productivity

The following graph, also from the article, shows how the trend in productivity growth changed about 50 years ago.

productivity trends fed economy

In addition to declining productivity growth, demographic trends in the U.S. and other developed countries are problematic. Population growth among the world’s leading economies is growing at a trickle and, in some cases, starting to decline. Consider the following population growth rates for the top five economies:

  • United States +0.1%
  • China +0.1%
  • Japan -0.5%
  • India +0.8%
  • Germany 0.0%

Equally alarming is the increase in the elderly population as a percentage of the entire population. For example, the chart below from the United Nations shows the dramatic shift in China’s population between 2015 and forecasts for 2040.

china population scenario demographic soft landing

Similar, albeit less severe shifts are expected in the U.S. Declining population growth, and a growing financial dependency by the baby boomers will reduce GDP.

Barring any trend changes in productivity or demographics, we should expect GDP growth to continue to drift lower.

Fed Juice Counteracts Productivity and Demographics

The Fed uses monetary policy to boost the economy and counter the aforementioned deteriorating economic building blocks. Lower interest rates and the accompanying debt-driven consumption grew the economy above its natural growth rate. However, in the wake of this strategy lies a highly leveraged economy that is exceptionally vulnerable to higher interest rates.

The table below shows that debt as a percentage of GDP has risen from 210% to 275% this century. Over the last 22 years, GDP grew by $16 trillion while debt increased by $52 trillion. Is that sustainable?

fed debt to gdp changes productivity

The more leveraged an economy, the more sensitive it is to interest rate changes. Reducing interest rates makes servicing the debt and repaying the principal easier. However, higher interest rates make servicing and repayment more costly.

We can think of higher interest rates as a tax on the economy. The Fed’s juice of years past, low-interest rates, is being replaced with the highest interest rates in fifteen years. High-interest rates are stifling new debt creation. More importantly, borrowing to repay old debt introduces a financial shock to the borrower and a tax on the economy.

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Current Scenario

If the expected growth rate is sub 2% and higher interest rates are and will be extracting a heavy tax on the economy, why is the economy running hot? The answer likely lies in the pandemic-related stimulus and the psychology of consumers. Both stimulus and irregular consumer behaviors support extra growth.

While the no landing crowd likes to think the relatively high economic growth is sustainable, we got news for them. The means supporting such strong economic growth is not likely to continue.

The blue line below shows that personal savings have fallen to a 12-year low. The growth of credit card debt has swelled to a 25+ year high. Unless wages spike higher, many consumers will cut back as savings deplete and credit card limits are reached. Further, higher interest rates on credit cards will reduce their spending ability.

We remind you personal consumption accounts for nearly 70% of economic activity.

personal savings and credit card usage economy

Is this Time Different?

The no landing scenario crowd assumes this time is different. Therefore, by default, they argue the graphs and bullet points below are irrelevant.  

  • A recession occurred every time the 10-year/ 3-month yield curve inverted and then un-inverted.
  • Fed rate hikes have preceded each of the last ten recessions.
  • Except once, in 1965, every time the ISM manufacturing index fell below 45, a recession occurred.
  • A recession occurred each time the Philadelphia Fed Index was at its current level.
  • A reading of over 50% of Deutsche Bank’s recession probability gauge preceded each recession.
  • The current level on the 85-factor Chicago Fed National Activity Index (CFNAI) and the OECD leading indicators are commensurate with prior recessions.
soft landing yield curve and recessions economy
fed funds and recessions
productivity ism recessions economy
philly fed recessions forecast
deutsche bank recession probabilities
chicago fed national activity index forecast
oecd leading forecast economic indicators gdp
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Maybe UFOs have wealthy aliens onboard wanting to buy a lot of stuff and boost our economy. Most likely, those forecasting a no landing have a false sense of optimism as the economy has thus far proven resilient.

Time is not on the no landing scenario’s side. With every passing day, the effect of yesterday’s interest rate hikes will weigh more on the economy. As we wrote in Janet Yellen Should Focus on Hope, understanding the progression of economic activity deterioration and the time lag between monetary policy changes and full consequences helps us appreciate that a no landing scenario is a pipe dream.

We hope for a soft landing but fear the more typical hard landing is the likely course. We caution those who believe the economy is unaffected by interest rates. It is dangerous to believe this time is different!

Apartment Rents Will Dampen Inflation

Housing comprises almost 40% of CPI, of which rents account for about three-quarters of that amount. Therefore, to help forecast CPI and, notably, consider what the Fed may or may not do, let’s closely examine rent costs, particularly apartment rents. To do so, the graph below shows that owners’ equivalent rent (OER), mainly comprised of apartment and house rental prices, has risen. At first glance, the chart does not portend that inflation will fall immediately. However, OER lags months behind what is happening on the ground.

To further help, we share a WSJ to assess how apartment rents and OER might impact CPI. In Apartment Rents Fall as Crush of New Supply Hits Market, the author states: “Apartment rents fell in every major metropolitan area in the U.S. over the past six months through January, a trend that is poised to continue as the biggest delivery of new apartments in nearly four decades is slated for this year.” The article notes that nearly 500,000 units will hit the market this year, the most in 35 years. It also states many tenants are maxing out the rent they can afford.

OER will fall in the coming months. As we share below, the OER price index (blue) is over 10% above its 35-year trend line. Therefore we believe the recent increase is an anomaly that will correct as the supply-demand equation normalizes quickly this year.

oer housing apartment rents inflation

What To Watch Today


  • Advance Goods Trade Balance, January (-$91.0 billion expected, -$90.3 billion prior)
  • Wholesale Inventories, month-over-month, January Preliminary (0.1% expected, 0.1% prior)
  • Retail Inventories, month-over-month, January (0.5% prior)
  • House Price Purchase Index, quarter-over-quarter, Q4 (0.1% prior)
  • FHFA Housing Pricing Index, December (-0.1% prior)
  • S&P CoreLogic Case-Shiller 20-City Composite, month-over-month, December (-0.54% prior)
  • S&P CoreLogic Case-Shiller 20-City Composite, year-over-year, December (6.77% prior)
  • S&P CoreLogic Case-Shiller U.S. National Home Price Index, year-over-year, December (7.69% prior)
  • MNI Chicago PMI, February (44.3 prior)
  • Richmond Fed Manufacturing Index, February (-11 prior)
  • Conference Board Consumer Confidence, February (108.5 expected, 107.1 prior)
  • Richmond Fed Business Conditions, February (-10 prior)
  • Dallas Fed Services Activity, February (-15.0 prior)



Market Trading Update

As noted yesterday, we were expecting a rally this week following last week’s selloff. The rally yesterday was disappointing, but the market did hold support at the 50-DMA and the rising trend line from the October lows. As long as that support holds, the bulls retain control. We are working through the current sell signal that started on February 10th. These signals tend to last 4-8 weeks before they complete, so we have some more work to do short-term.

Market Trading Update

Morgan Stanley had a interesting take as well.

“The S&P 500 has recently been trying to break the well established downtrend that defines this bear market that we think remains incomplete. The question for investors is whether this signifies a new bull market that began in October or a classic Bull Trap? Without any fundamental view, most technicians would likely take the more positive outcome: i.e., new uptrend being established. However, we do have a strong fundamental view; therefore, we are inclined to conclude this as a bull trap.

In addition to earnings risk, we also have extreme valuation risk (Equity Risk Premium still at a historically low 168bps after last week’s sell-off), and we could argue positioning and sentiment is neutral at best and even bullish on several measures. We would also point out that much of the rally since October has been driven by non-fundamental flows (trend following strategies) that have been flattered by extraordinary global liquidity that may not continue to be supportive. In other words, in our view, this support looks rather weak and can quickly turn into resistance if the S&P 500 drops a modest 1 percent further.

Market Trading Update 2

Continue to use rallies to reduce risk and raise some cash. We are starting to buy longer-duration bonds in small amounts as yields approach what we expect will be the Fed’s terminal rate.

Jim Colquitt Chart Review

Jim Colquitt, Founder and President of Armor Index ETFs, is now regularly publishing on Real Investment Advice. For more information, check out his debut article, Do Not Be Fooled. Jim also publishes a weekly chart book. Therefore, we chose a few excerpts below to introduce you to Jim better.

In the first chart, we’re looking at the S&P 500 Index. If you’re a bull, you have to be hoping (praying) that last week’s price action was simply a retest of the prolonged downtrend line and that it will bounce from here.

chart review colquitt spy

It looks more likely that this is a very similar pattern that we’ve seen repeat itself repeatedly since the beginning of 2022. One where we see a sustained rally for several weeks only to have it break down and move appreciably lower.

You can see this in the chart below, denoted by the blue trendlines. Note that each of these moves was foreshadowed by a rounding top.

chart review colquitt spy bearish

Having spent a fair amount of time in the high-yield bond market, I tend to believe that high-yield bonds lead equities. With that said, note what HYG is showing us. Similar pattern as above except that HYG is on week three of the downtrend.

chart review colquitt hyg

Inflation Expectations

On the heels of last week’s higher-than-expected PCE inflation data and CPI and PPI from the prior week, it’s worth revisiting how inflation expectations are affected. The first graph shows inflation expectations for the next five years (red), ten years (purple), and for the five years starting five years from now (blue). They have all upticked but not in a concerning manner. Further, they have fallen decently over the last year but remain about half a percent of the pre-pandemic range.

The second graph is a bit different. The BofA graph shows the percentage of investment managers surveyed who think global inflation will be lower in the year ahead. As shown in the graph, it is now at a record low.

inflation forecasts
inflation cpi expectations survey

Martin Zweig’s Trading Rules

Martin Zweig, a successful, highly regarded stock investor and author, published his 17 investing rules in 1990. His guidance is still highly valid and worth reminding ourselves of.

  • The trend is your friend.
  • Let profits run, take losses quickly.
  • If you buy for a reason and that reason is discounted or no longer valid, then sell!!
  • If the values don’t make sense, then don’t participate.
  • The cheap get cheaper, the dear get dearer.
  • Don’t fight the FED.
  • Every indicator eventually bites the dust.
  • Adapt to change.
  • Don’t let your opinion of what should happen bias your trading strategy.
  • Don’t blame your mistakes on the market.
  • Don’t play all the time.
  • The market is not efficient but is still tough to beat.
  • You’ll never know all the answers.
  • If you can’t sleep at night, reduce your positions or get out.
  • Don’t put too much faith in the “experts.”
  • Don’t focus too much on short-term information flows.
  • Beware “New Era” thinking, i.e. “This time is different.”

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