There's some talk right now that the current market environment resembles a "dead cat bounce" or that we're setting up for a recession. The former doesn't really hold much water, while the latter is possible it's looking like we could avoid it.
This week's musings are inspired by the classic 1974 hit song, "Cat's In The Cradle." The song was written and recorded by Harry Chapin and inspired by a poem written by his wife, Sandy. She wrote the poem because Chapin's son was born while he was performing on the road. The song reached #1 on the Billboard charts in the U.S. and sold at least 1 million copies worldwide.
"My child arrived just the other day
He came to the world in the usual way
But there were planes to catch, and bills to pay
He learned to walk while I was away
And he was talkin' 'fore I knew it
And as he grew, he'd say
"I'm gonna be like you, Dad
You know I'm gonna be like you
And the cat's in the cradle and the silver spoon
Little boy blue and the man in the moon
"When you comin' home, Dad?"
"I don't know when
But we'll get together then
You know we'll have a good time then"
The song has multiple applications to market events this week that we'll explore, so let's get into it.
Here's what we've seen so far this week...
The Cat's In The Cradle. For those claiming (or possibly hoping) that the recent action in the market resembles a "dead cat bounce," we would say that's probably not a very good analogy.
A dead cat bounce is a short-term recovery in a declining trend that does not indicate a reversal of the downward trend. A good example to review is the 4th quarter of 2000. At that point, we were 10-11 months into a bear market due to the Dot-com Bubble.
From mid-October to early November of that year (about 18 days) the market rallied 8.3%. However, the downward trend continued after November 6th and markets declined another 7.6% for the year. If we compare that example to the current market trend, we see a different picture. Equities hit a low on October 13th of last year. Since that point (168 days later) not only have equities failed to retest that low, but have reversed the trend and are up 15.9% since that low point. While it hasn't been a straight line higher, the trend has clearly reversed.
But There Were Planes To Catch, And Bills To Pay. The second common refrain that is permeating market commentary is that the Fed "broke something" in the economy and it's only a matter of time before the economy slides into recession.
It's possible the Fed "broke something," but it appears for now it's not the banking system. Money Market assets are certainly high, but have come down and the weekly increase is the lowest since the banking crisis began. This signals declining fear/panic in the market as it relates to banks. Among banks that utilize the Fed for short-term operations, it looks like the panic there is also subsiding.
The Fed's "Discount Window" (a short-term lending facility to help commercial banks meet short-term liquidity needs) has dropped for the 2nd consecutive week. The new Bank Term Funding Program (BTFP) has seen fewer loans week-over-week. Lastly, Credit Extensions from the Fed to banks (i.e., bridge loans) are flat week-over-week. Does this mean the worst is over? Not necessarily. However, it's a good sign. Have bailouts worked in the past? The answer is yes. Long-term Capital Management (LTCM) failed in 1998 and, while it was a hedge fund and not a bank, the total bailout was $3.7 billon (which in today's dollars is equivalent to $6.7 billion).
From the time LTCM began to fail up and until the bailout, the S&P 500 Index lost more than 22%. However, once the bailout was announced equities proceeded higher by 68% leading up to the Dot-com Bubble. Is that the way things will go this time? It's difficult to say. This bailout is different and the set-up in the market is different. However, given the drop in fear and volatility, it would appear that we're headed in the right direction, for now. However, I can see a scenario setting up similar to 1998 where maybe markets are strong until the real underlying issues reveal themselves in 12-18 months, but likely after a nice move higher in equities (perhaps beginning with the Fed announcing a pause in rate hikes in May).
You Know We'll Have A Good Time Then. There's been good and bad news on the economic front this week. Early in the week futures on the Fed Funds for May were showing 83% probability of no rate hike at the next FOMC meeting. As of today, those odds have flipped to 50:50 of not rate hike or 25 bps hike.
The good news is that we saw more progress on the inflation front. The Fed's favorite measure of inflation, the PCE Index, showed a lower than expected increase for February, but more importantly, dropped from 5.3% to 5% on a year-over-year basis. That's the 6th drop in the PCE Index over the last 8 months. The consumer's expectations of inflation moving forward also dropped in March from 4.1$ to 3.6% (4th decline in 5 months).
Personal Income and Personal Spending were both higher in February. Spending was lower than expected, however, and lower than the previous month. There are signs that the consumer is slowing down and the recent Banking Crisis could have caused the consumer to take a pause in March. We'll have to watch the spending numbers closely over the next several weeks to determine if the slow down is temporary or a developing trend.
Currently, the Fed's expectations for Q1 GDP are strong. The Atlanta Fed is showing 3.2% growth in real GDP for Q1, with no real change in consumer spending as a component of GDP. New Home Sales were slightly below expectations, but higher month-over-month. In addition, the Housing Market is showing some improvement in metrics. The Mortgage Market Index has improved for 4 consecutive weeks and the sales metrics (New, Existing, & Pending Homes) have stabilized and appear to be heading in an upward direction. The next few weeks are going to be critical to examine if the consumer and labor hold up as banking fears ease. The Fed's next meeting in May could make or break markets for 2023.
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