Smell a Rat

The stock market just doesn't seem to make much sense.  You have wild volatility in the bond market as financial crisis fears have changed market pricing for the next few months, from rate hikes to rate cuts.  The economically sensitive technology sector has taken the lead, based on some overzealous belief that its a safe haven as tech companies have lots of cash and low debt.  

It goes back to that gift that keeps on giving, the Covid stimulus, which was a huge boon for the wealthy and corporations, as they benefited greatly from fat PPP loans that were forgiven.  Corporations were also able to load up on low interest debt in 2020 and 2021, which set them up well for the next few years, locking in cheap funding.  The vast majority of the post Covid excess savings belongs to the wealthy, so they have lots of dry powder.  

It gives the top 10% very little incentive to sell stocks, because they already have a big cash hoard which is steadily getting bigger with nearly 5% interest on cash.  It doesn't matter what the bottom 90% do with their money, they don't have the firepower to move the SPX.  Only the top 10% do.  And the top 10% don't need to sell stocks because their balance sheet is stuffed with cash and low interest debt.  Here's a chart from a Next Economy substack post, (by the way, an excellent blog), showing the net financial position of households by income percentiles.  All the excess savings is in the top 20%, everyone else is below pre Covid levels. 

This most recent SIVB induced selloff just didn't have that staying power of those in 2022 because bonds rallied this time, which buffered a lot of portfolios against the volatility.  Anytime bonds rally in a stock market selloff, it provides a natural hedge for investors, and they have less fear and urgency to sell because their 60/40 stock/bond portfolio is not losing much.   Once the Fed stepped right in to bailout the banks, the banking crisis fears were overblown.  The Fed will always shows its true colors when the going gets tough.  Their main priority is to support growth/employment.  They love bailouts.  It makes them feel important and powerful.  They feel like a hero.  It pumps up their ego.  Inflation always takes a back seat in these situations.

Even though the Fed immediately brought in their bazooka to stop the panic, bank runs and banks going belly up make investors nervous, as they get 2008 flashbacks.  When investors are nervous, unless earnings are seriously getting hit, the headlines eventually fade away and stocks usually have a strong bounce back.  Based on leading indicators, earnings should go down rapidly in the 2nd half, so there could still be a couple of months of hopium for the bulls as they latch on to Fed pivot hopes. 

While financial contagion worries are prevalent, I don't think they are as important as everyone thinks, since the Fed WILL blow out any small fires with a firehose of liquidity.  The bigger problem, which will take some time to play out, is the deposit flight from the banks as the spread between bank savings rates and money markets funds are too big for even the lazy to ignore.  This fire can only be taken out by the Fed if they cut rates aggressively, which they don't seem too keen on doing at this juncture (expect that attitude to change in the summer).  

This exit from bank savings/checking to money markets will be a slow squeeze on the bank's main source of cheap funding (near zero rates), hurting profitability and reducing their ability to make loans.  The banks pull back on loan issuance and tighten credit to weather the storm.  That credit contraction will feed into the real economy over several months, so nothing dramatic in the short term, but it will be felt more and more later this year.  The banks were already tightening lending standards, as shown by the senior loan officer survey.  This will eventually cause less credit to flow, reducing economic activity, and leading to lots of layoffs. 

While its always alluring for bears to latch on to the big bang story of banks going under and a financial crisis, that's fighting the last war (2008), which the global central banks will not let happen, seeing how quick they are to bailout any systemically important bank/institution.  The less sexy bear thesis is an ordinary credit led contraction, where banks lend less money, investors hoard cash and hunker down, job losses pop up as the economy gets worse, earnings go down, reducing buybacks, taking away a key support for the stock market, and the excesses of the previous bubble get wrung out of the system as zombie companies die out in the first real recession in 14 years.  Instead of a big bang from a domino financial contagion event, the much more likely scenario is that of an old fashioned recession, this time with commercial real estate the weak point, along with manufacturing weakness.  It will be a slow bleed.  The economic data will get worse as the year goes on.  The main question is how bad does it get.  Many are predicting a mild recession.  But considering how much the Fed raised rates, and how long it has been since the last recession (2009), along with low organic growth, it would not surprise me if we get a deep recession this time.  

The SPX looks to have a short term ceiling at 4000, and a short term floor at 3900.  I am not going to play the range, but if I had to, I would rather be a buyer near the floor, than a seller near the ceiling.  I smell a rat in the stock market.  It seems like it wants to suck in the shorts, trapping them before eventually squeezing higher.  Its too resilient and it looks like it wants to go higher eventually after a bit more basing this week.  SPX 4150 by mid April would not surprise.