Culling the Herd in Banks

Powell just pulled forward the date of the first cut by hiking again.  Now you will have a reverse repo facility offering over 5% on cash, while banks pay next to nothing on deposits.  That magical 5% number sounds much higher than a rate with a 4 handle. 

People are bad at math.  You have people with savings accounts that pay less than 1% interest while holding credit card debt they are paying over 20% interest on.  Many don't understand how much interest income they are giving to the banks by not moving excess cash from their bank to a money market fund.  $100,000 earning zero at the bank is basically giving up $5,000/year to the bank in income.  

But things are changing.  Interest on cash is now in the news.  You have interest from a money market account on a magazine cover.  Cash earning market interest rates are popular.  Banks need sticky deposits, that don't care about the interest they get.  People didn't care when rates were at zero because they weren't losing out by keeping excess cash at the bank.  Since SIVB, people are starting to care.  That's bad news for the banks. 

In the age of social media, news travels fast.  The more that regional banks are in the headlines, the more negative exposure they get, which encourages more deposit flight.  It doesn't help when you see banks plunging on news that they are looking to sell (PACW).  Its not evil short sellers attacking these stocks.  These companies are up for sale because in a 5% Fed funds rate environment, deposits are no longer sticky, and money starts to move to where there is yield.  

With the crap long duration mortgages and low fixed rate loans on their books, if these banks have to make up for the deposit losses with wholesale funding at market rates, they can't make money.  They become walking zombies.  And for a bank, when you become a zombie, the stock price goes down a lot, which makes depositors nervous, which induces more deposits to leave, creating a vicious circle.  Sure, PACW can survive in the current state if none of the deposits leave.  That goes for all the regional banks whose stocks have been getting pounded.  People selling these regional stocks are not worried about the current state.  They are worried about the future state.  A future with much fewer low cost deposits as deposit flight continues to those seeking higher risk free yields.  People are dumb, but not that dumb.  Eventually they catch on to the banks ripping them off on their .01% yielding deposits. 

These regional banks can't survive for long unless Powell takes rates drastically lower, and quickly.  In all likelihood, a bunch more of the regional banks will have to go bust first before those big rate cuts happen.  Its survival of the fittest for the regional banks.  Those with the fewest CRE loans and long term debt on their books will survive.  Those that got greedy seeking yield in 2020-2021 on their assets by going out in duration will be the most vulnerable to getting culled in the coming months.  

This culling process is going to be disastrous for bank lending.  The demand for credit was already going down before the SIVB debacle happened.  At these elevated rates, with a slowing economy, it just doesn't make sense to make long term investments.  That's the demand side.  The supply side situation for credit is even worse.  Regional banks make up a huge portion of commercial real estate and C&I lending.  Seeing how their deposit base is getting less sticky, they will be making big cutbacks on lending to the real economy.  Credit is starting to freeze.  

Credit is the best leading indicator for the economy.  More money flowing through the economy generates growth.  Turning off that spigot eventually catches up to the economy as new loans get turned down and loans coming up for renewal are not extended.  Its not going to be a sudden event, but more of a slow squeeze, sucking oxygen out of the patient.  Once you get to a critical point of too little oxygen, its game over. 

The SPX is hanging tough, just selling off a couple of percent before the dip buyers come back in and rally the market again.  A lot of this bid over the past month has been coming from dumb beta systematics that are upping their equity exposure as the volatility goes down.  Corporate earnings still haven't reached the precipice of the cliff, so the buybacks are still heavy.  Investors are a bit nervous, but they aren't selling.  Take a look at the flows into technology funds since 2007.  It went parabolic in 2020-2021.  And they haven't sold. 

Tech stocks are still loved.  Going into a recession that will probably be deeper than most expect.  Not a great set up for Nasdaq.  It boggles the mind to think that AAPL, MSFT, and META are considered safe havens in a recession.  Those are 3 economically sensitive stocks with slow growth.  The love affair for big cap tech stocks is so deeply ingrained in investors that they act as a safety blanket when you have these bank crisis headlines. 

Its gotten to the point where I think it will be better to just short Nasdaq instead of SPX when the time is right.  Maybe it happens after the debt ceiling gets done and investors breathe a sigh of relief.  From past experience, its risky to short when you have bad news headlines dominating the tape like you have this week with the regionals.  

In all likelihood, the Fed is done with its hiking cycle, especially with the continued stress in the regional banks.  I made a wrong assumption that a Fed hiking while not making any mention about future tightening would be celebrated.  But investors just couldn't sit still on the banks and started selling the banks aggressively right before the FOMC meeting.  That was definitely unexpected, especially after the uncertainty of FRC was taken off the table as JPM took them over.  The grace period after that was less than 24 hours.  Now the market's main focus is on the banks, and that's not an environment where you will get institutions chasing stocks higher even after the Fed basically said in their round about way that they are pausing.  So I missed a good short there in SPX on the end of April rally. 

Its been 7 weeks since the SIVB panic so that's plenty of time for this rally to exhaust itself and run on fumes.  It appears we won't be getting that run to SPX 4200 on a Fed pause.  There's nothing bullish about a Fed that stays stubbornly above 5%, barring things breaking.  An FDIC guarantee on all deposits doesn't matter.  Its about yields now.