Since Silicon Valley Bank’s collapse in early March, only one stock factor has mattered for performance: size. The graph below, courtesy of Bloomberg, shows investors began to play favorites based on size (market cap) once the bank stress among regional banks started. Recent performance implies that larger companies will not be affected by the tighter lending standards that are sure to accompany the banking crisis. Many mega and large-cap companies have access to the bond markets for capital and can avoid relying on banks. Currently, the corporate bond market shows no stress. Also important, some of the liquidity the Fed and government may use to support banks will flow into the largest-sized companies due to popular passive investment strategies.
The market’s logic seems to make sense but should come with a disclaimer. According to a recent Forbes article, small businesses employ 61.7 million workers, about half the labor force. Many small companies rely heavily on working capital loans from banks. If said loans are more costly or harder to get, layoffs and bankruptcies will follow. Regardless of access to capital, large and mega-sized companies will see sales and earnings growth weaken if smaller companies struggle.
What To Watch Today
How Do You Know When You Are In A Bull Market?
One of the keys that you are in a bull market is when really bad news hits, and the markets rally. Such was the case yesterday when First Republic Bank failed over the weekend and was bought by JP Morgan. There are two important takeaways from the market’s response to history’s 2nd largest bank failure. The first is that the market rallied at the open of the market yesterday, and the second, is that credit spreads remained muted.
When you have an event of this magnitude and neither the stock nor bond market blink, you are in a “bull market.” Such is shown in the chart below. Despite the bearish rhetoric, there is nothing bearish about the market action currently. While we can certainly see a 5% to 10% pullback this summer, which is normal for any given year and expected, I would use that pullback to build equity exposure until, unless the long-term bull trend line is broken.
The bears will have another shot at the market this week with the Federal Reserve meeting on Wednesday. If Jerome Powell is more hawkish than expected, we could see a bit of a correction by the week’s end.
First Republic- Second Largest Bank Failure
The FDIC seized First Republic (FRC) on Sunday, and its assets were sold to JP Morgan. The FDIC will retain its liabilities and lose approximately $15 billion. Shares of JP Morgan rose on Monday as they will buy about $18 billion in assets for $10.6 billion, according to some estimates. They will immediately recognize a $2.6 billion post-tax profit and more over time.
Small banks may fail as depositors continue moving funds to larger banks and money market funds. The net result, the largest-sized banks, those labeled too big to fail, will grow. While such evolution will consolidate bank assets and liabilities into larger, more regulated banks, it will also raise moral hazard if these larger banks have problems.
As we note in today’s opening, size matters. Within SimpleVisor’s relative and absolute analysis tools are the following graphs below. They help further highlight the performance divergence by size over the past month and a half. The first graph uses the price ratio of large-cap MGK to small-cap IWM and applies a series of technical analyses to the ratio. As shown, it has a score of .74, approaching very overbought. The second graph shows that MGK is overbought from a relative and absolute framework and has been so for the last three weeks. Conversely, IWM has remained in oversold territory for the same period.
Fed’s Recession Probabilities Soaring
The graph below from the New York Fed shows the probability of a recession a year from now is 58%, the highest since the early 1980s. Not surprisingly, the graph aligns with the shape of the 2/10-year yield curve. The more inverted the yield curve, the greater the recession odds. The yield curve is currently inverted by 60 bps, the most since the early 1980s.
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