How Much More Stress Can These Markets Handle?

0:00If you've been considering futures trading, now might be the time to take a closer look. The futures market has seen increased activity recently, and Plus 500 Futures offers a straightforward entry point. The platform provides access to major instruments, including the S &P 500, NASDAQ, Bitcoin, natural gas, and other key markets across equity indices, energy, metals, forex, and crypto. Their interface is designed for accessibility. You can monitor and execute trades from your phone with a$100 minimum deposit. Once your account is open, potential trades can be executed in two clicks. For those who prefer to practice first, Plus500 offers an unlimited demo account with full charting and analytical tools.

0:45No risk involves while you familiarize yourself with the platform. The company has been operating in the trading space for over 20 years. Download the Plus500 app. Trading and futures involves the risk of loss. It is not suitable for everyone. Not all applicants will qualify. Hey, everyone. If you like this podcast, go behind the paywall to get privileged access to the smartest minds in finance. Visit realvision.com slash RVpod and use the promo code podcast10. That's podcast10 to get 10 % off our essential membership for the first year. Join the Real Vision community and learn how to become a better investor.

1:24And now to the top analysis of today's markets.

1:34How much more stress can these markets handle? Welcome to Real Vision Daily Briefing. It's Wednesday, April 26, 2023. I'm Ash Bennington. I'm joined today by Jason Trenner, Chairman of Strategas. Welcome, Jason. Nice to be here. Thanks for having me. Well, I was about to say welcome back. You've been on many times. You're one of our favorite guests. Our audience always appreciates your insight. Jason, I want to lead off with a quote because I think it's so powerful from an investment strategy note from your shop, Strategas Securities. This is from Monday, April 24, 2023. With the sheer amount of fiscal and monetary meddling in the economy during the pandemic, it would seem that almost anything is possible.

2:14We were just talking about this offline, what a difference 48 hours can make. Jason, where are we right now? What does it all mean? Yeah, that was actually a disclaimer before I gave my opinion to inoculate myself in case I was wrong because I have to say I'm very cautious about the markets and worried about the economy. But, you know, it's when you when there are no rules, anything can happen. And this has been a broken play really since the GFC, but particularly since the pandemic. But my own opinion is that whatever you thought, one would have thought the odds of recession were before the regional banking crisis started in earnest with Silicon Valley Bank and Signature that they have to be considered higher now.

3:06And so in my opinion, we were just in the early innings of what's going to be some tough sledding for both the markets and the economy. Yeah. And it's interesting because the intermediating factor here, the question that we're all thinking about here today is the question of the role that the banking system is going to play in this as a transmission mechanism or potential transition mechanism. I should say, obviously, the big news of the day is what's happening over at First Republic FRC. If we could bring up that chart, I just wanted to show our viewers this. We're off almost about 30 % here on the day.

3:42Five-day chart, we're off nearly 60%. And when we look on a year-to-date basis, First Republic Bank off 95 plus percent year to date. These are very big moves. Obviously, this is a story that's a question in itself about what's going to happen to First Republic, but also the broader question about what is happening to the regional banking system here in the United States and its implications for the broader macroeconomic perspective. Jason, what are your thoughts? Well, First Republic is actually a client of ours, so I'm going to refrain from talking about them specifically. But I think, Listen, I think their issues are issues of a lot of other banks, not all of them.

4:21But if you look at Silicon Valley Bank and perhaps First Republic, they have certain things in common. But as I said before, if you look at one of the things we look at very closely is the Fed Senior Loan Officer Survey, which asks banks, are they more or less willing to make loans? We're going to get a fresh figure for that in two weeks. But the latest figure showed a pretty big increase in banks' unwillingness to make loans. That generally has a pretty strong correlation with job losses and corporate profits. And so I can only imagine that it's worse now than the last data point we got, which was late in January or early February.

5:08And so the banking system obviously is the oxygen of the economy, particularly for small businesses. Larger businesses can rely on non-bank banks. They can rely on private equity or venture capital or other sources of funds. But for most – Capital markets. Capital markets. Most small firms, most small companies are highly dependent upon bank loans. And to the extent to which banks are unwilling to make loans or find it difficult, that puts a lot of strain on small businesses, which are generally speaking very much responsible for a lot of the hiring that happens in the economy. Yeah, you know, it's so interesting.

5:55One of the reasons the U.S. economy is so dynamic for people who don't think a lot about the banking sector, we've got some 4 ,000 banks here in the United States. If we compare it, for example, with Canada, who has a very small number of highly concentrated large banks, it's a different economy. One of the things that gives the U.S. economy its dynamism is small, medium-sized, and regional banks. And if that were to go under threat for whatever reason, it could pose a serious risk to the economy moving forward. Amen. I mean, I feel very strongly – I mean, this is my chosen profession, financial markets, banking, that type of thing.

6:27But by the same token, I feel very, very strongly that one of the reasons why the American economy became the American economy is because of the depth of its capital markets. and the depths of its banking system. And the banking system is very local, which can, in an economy as large as the United States, can be really as variegated and differentiated among regions. It's very important to have local banks, in my opinion. So this isn't something to trifle with. I'm sure the Fed is looking at the developments very, very closely. Whether it will be enough to prevent them from tightening next week, We don't know yet.

7:09They may not know yet, depending on how this shakes out. But it is something, there's no question in my mind, that the Fed is taking very seriously. Yeah, John Williams, the president of the New York Federal Reserve Bank, said in a statement a couple of weeks ago, and I'm going to paraphrase here, but essentially one more rate hike probably is about right. And as you point out, this may be very much in question if there's the perception of a tightening in financial conditions. It's an ash you mentioned this before. I mean, it's it's difficult because a lot of the other things that you would look at that maybe are not just up to the minute, like the stock price of the regional banks are suggesting the economy is quite resilient.

7:47Right. And particularly the labor market, which is something that the Fed pays, I think, a lot of attention to more attention to the labor market, maybe than other economic statistics. And it's hard to really claim that the Fed should ease if the unemployment rate is 3.5%. I mean, if you're at full employment, it's hard to make a strong case, it seems to me. But financial stability is not part of their mandate officially, but it is clearly something that's on their minds. I'm expecting them to tighten next week unless this really falls apart. But it also wouldn't surprise me if they took a pause after that to see how their policies are impacting the economy, because monetary policy obviously acts with a lag, and the lags tend to be, as they say, long and variable.

8:41So, you know, you don't quite know how what you did even three months ago is going to impact the economy six months or a year from now. Well, you know, it gets into something that you wrote in the note. In fact, the quote that I thought was so profound about this idea that we are truly through the looking glass now because of extraordinary intervention with unconventional monetary policy and massive fiscal policy. So you get to this point where, as you suggested, a three and a half percent unemployment rate is not the typical environment in which you'd expect the Fed to start cutting rates. However, however, some of these historical correlations have broken down and you wonder whether or not there are risks in the economy in either direction, frankly, that are not traditionally correlated as we have seen them under their historical precedence.

9:23It's a great point. And I think this is one of the not to pile on the Fed here, the Fed's doing the best they can. But, you know, we've described their monetary policy. It's a little bit like the Hotel California, you know, the old Eagles tune, which is, If you remember the line, you can check out anytime you want, but you can never leave. And here the Fed with the assets on the Fed balance sheet at eight and a half trillion dollars, it's very hard for them to exit all of this extraordinary monetary stimulus that they have created without something breaking. And so and no one really wants to have the pain.

10:00And yet you have to fight inflation. And so it puts the financial markets, puts the economy in a more precarious position. than it might ordinarily have been in. And so I had no problem with the first round of quantitative easing, but once you started to get into QE2 and three and four, and it's again, very, very hard to extricate yourself from this elegantly. You know, it's interesting, you mentioned this term until something breaks, that's something that we in the space talk about. It's a bit of jargon, people bandied about back and forth. And then when you see a failure essentially of three banks, Silvergate, Silicon Valley Bank, and Signature, all sounding disturbingly alike to the lay public's ear.

10:46But when you see these problems arising simultaneously and someone says, well, this is what we mean by something breaking. And obviously, that's why folks are watching a whole series of regional banks in the market right now to see if there's going to be continued breakage. Yeah. And the banking system, I think, is obviously, as I said, it's like the circulatory system for the economy. It's sufficiently large so that if it does become systemic, it's very, very serious. There have been other things that have broken that were speculative, let's say like the SPAC market or crypto or so on. And they broke, but it obviously wasn't systemic, wasn't something that really threatened the system itself.

11:29I would say this has the potential, obviously, to be much more serious. I do think there are characteristics of these banks that make them unlike most other banks, just the extent to which they tend to focus on very large depositors, very wealthy depositors. Their deposit base may not be as variable as other banks. And by the way, for those who may not know, the reason that that's important is because if you have a large percentage of high net worth depositors with large accounts, it puts a larger percentage of your deposits over the FDIC insurance limit. And so you have essentially this potential for people to be exposed.

12:11And that's one of the reasons why you see this risk in potential deposit flights. That's right. And then, you know, once you start, it can become, as we've seen with Silicon Valley Bank, a vicious circle where you have held the maturity securities, which you don't necessarily have to acknowledge losses on because you're going to hold them to maturity until you might have to sell them to meet the depositors' requests for their money back. And then they become capital and then it becomes a whole other issue. Then they get marked for people who may not understand the cycle. Then they get marked to market, meaning you look at the current prevailing rates at which they're trading.

12:50When you have interest rates rising very dramatically, it dramatically pushes down the values and securities on the asset side of the balance sheet. And what you wind up with is this asset liability mismatch that you essentially have to realize in real time. And you get this massive tilt, as we've seen. That's exactly right. And I think, you know, a lot of this, again, not to pile on the Fed, but this is a little bit of the issue, again, with the amount of meddling that we've done and the volatility that you've seen in the bond market, right? I mean, the bond market shouldn't necessarily be as volatile as it's been over the last couple of years.

13:27But when the Fed purchases$5 trillion worth of securities in a year and then tries to stop, it stands to reason that something might break or that you're going to have a lot more volatility in things that you normally thought were quite safe, like treasury securities. We're going to take a quick break and be right back with more of the day's top analysis on the Real Vision daily briefing.

13:55Yeah, and you know, one of the important points to mention here probably is also rate of change. When people look at rates, you know, the federal funds rate at 475 to 500 basis points right now, it sounds pretty middling. But when you think about the rate of change at which that happened, pretty extraordinary. And you have essentially this liability asset mismatch happening on balance. He's talking about rate of change. Another point related to that, a point that our friend Jim Bianco made with me. I had a conversation with Jim this morning on Crypto Daily Briefing. But what's interesting is that obviously there are these macro drivers on crypto and on the traditional financial side that are driving both sets of markets right now.

14:32And Jim made this point, which was, I believe he was speaking about Silicon Valley Bank. He said, look, this was a very rapid unwind. It took hours for this mass exodus of deposits. We had a very rapid unwind in the 1980s of a bank, and it took two weeks. The fact that people can just jump on their cell phones and move funds essentially makes everything happen in hyperdrive. Absolutely. And I think this is not something I'm not a huge fan of regulations, generally speaking, but this is probably something where maybe some speed bumps, it at least should be looked at. And obviously, if you have deposits, you want instantaneous access to your money.

15:09But as you know, there's no bank that could survive a run on its deposits. I mean, that's the opposite of what banking is. It's not a warehouse for funds. It's a bank. And leverage is an inherent risk and part of banking. Now, you can do it safely. But I also think the modern banking system is not really designed for a company like Silicon Valley Bank to lose 40 % of its deposits in four hours, right? I mean, there's no bank that could survive that. So I want to switch gears here a little bit and talk about something that you speak about in your note, I think very eloquently, which is the correlation between recession and market bottoms, particularly U.S.

15:54equity markets, S &P 500. You have a table in there that I think is really interesting and really instructive that shows the time differential between the onset of recession and the bottoming in the S &P 500. And what you can see, obviously, there's some variability on that chart, but in some cases, it can be extremely long. Absolutely. And I think, you know, as the reason why I put this in here is that one of the questions I've received the most from our clients, institutional investors over the last couple of months is, gee, this is the most widely anticipated recession of all time. why won't investors just look through it?

16:32Why do they have to sell it all? Why won't they just accept this as part of the natural business cycle? And why does there have to be a bear market that's worse than what we've already seen? And what I'm trying to tell people here with this chart is that once the bullets really start flying in a recession, stocks go down. So once you start to see people get laid off and profit expectations get cut, you're going to, the market's likely going to go down. And it sounds easy in theory to look through it to the other side. But in practice, I think it's very, very difficult. And again, you can drive a truck through these numbers and you never really know when the recession starts until well after the fact based on the National Bureau of Economic Research.

17:24But I would argue the recession has not really started yet. in earnest, mainly because the employment markets are so tight, which means that I still think there's risk in the equity market. There's a lot of my clients that believe that the bottom we saw last October is the bottom. I hope they're correct, frankly. But if you're expecting a recession as I am, I would say that the odds do not favor that. The odds would favor that we're going to retest those lows at some point this year. Jason, talking of recession watch, you have another great chart in your sheet. This is the note that came out from Strategas about the New York Fed probability of recession in 12 months ahead predicted by Treasury spreads.

18:07I believe this is three months minus 10-year UST spread. If we could bring that up on the screen and if you could talk through it, you can see the gray bars there represent recession and I'll let you talk about the indicator. Yeah, no, this is, listen, yield curve is, it's not, it's not perfect. Two years, 10s is not perfect. Three months, 10 years, actually, I believe is perfect in forecasting recessions. And right now, the spread between the three-month bill and the 10-year note is wider than it's been at any time since 1981. And you can see here with those gray bars, anytime it spikes, you get a recession.

18:47And so this is something I believe investors should take seriously. I don't think this is just a one-off. I think you've had an inverted yield curve here for quite some time. And right now, again, you have the bond market and the stock market essentially telling you two different things about the likelihood of recession. And in my opinion, right now, the bond market is probably, I believe, is going to be more accurate in the end. Yeah, bond markets traditionally have a better track record than stock markets in predicting forward recessions. It's also interesting. I'm just kind of eyeballing this chart, but it seems like it's around 30 basis points where you start to see the correlation essentially go to one.

19:34And we're at double that. Yeah, right. So this is, you know, again, this is something you haven't seen since 1981. and you remember in that era, in and around that era, that was a period of time when inflation, I believe, peaked at about 15. Fed funds rate peaked at 20 to 21, something along those lines. So you're dealing with a much wider scale too, a much bigger scale to have that kind of inversion. So this is, again, something that I think investors should take seriously because it's telling you that investors are very, very worried. It's telling you that their investors and bonds are very worried about the possibility of recession.

20:20We're going to take another quick break and be right back with more of the day's top analysis on the Real Vision Daily Briefing.

20:32Jason, we have a lot of great questions coming in for our audience. I would love to hit some of these if you're game. Sure. Fantastic. The first one comes to us from Oliver M. from the Real Vision website. Oliver, boy, this is a cynical question. Are these considered zombie banks or are they totally dead now? Wow. I, you know, I wouldn't go so far. I'm not even sure I would describe them as the banks that we're talking about are at a minimum zombie banks. And they might be dead. I don't know. I think, again, the banking system in the U.S. is very diverse, which don't necessarily have the same sorts of profiles in terms of their depositors and the people to whom they're lending.

21:23So I'm not quite so sure it says systemic, but these banks are going to, if they're not already in receivership, they're clearly going to have to have some help from someone if they're going to survive. Here's one that comes from Edward Sanders from the Real Vision website. I don't know if this is something you follow, Jason, but Edward is interested in your take on what the home builders are signaling. I don't have a strong opinion there. I think there is a certain amount of cash that's still left in the system. There's still a fair amount of savings. And there is, I would argue, there's a housing shortage in a lot of parts of the country.

22:08And so you have a strange situation here where you have these types of troubles in the banking system, which we spent a lot of time talking about. And yet there are other parts of the economy that seem to be doing okay and can withstand somewhat higher interest rates to people who have been looking for opportunities to buy a home and have cash. And so, you know, I think the good news is that the home building sector largely, I think, is consistent with the fact that you're close to full employment. You know, the question I would ask is, you know, how sustainable is that? if the employment market starts to weaken.

22:50But I would say that's been one of the brighter spots in the U.S. economy. And I think it's partly because the affordability of homes got to be so out of whack that to the extent to which they're becoming somewhat more affordable, there are people with cash that are willing to buy them. Here's a question from Golden Taurus Finance from YouTube. Will the Fed step in for small banks or will they let some of them go under? This is really a great question, particularly since we saw the Fed, Treasury, and FDIC backstop Silicon Valley Bank, the idea being that there was fear of systemic risk. Do you think that if the event of another insolvency, the Fed and FDIC and Treasury will step in?

23:30It's a great question. And I have to say, too, and this is my hope, because we've wondered aloud here in our shop when Silicon Valley Bank fell. So, you know, listen, if this were a bank in East Palestine, Ohio, would it have been treated the same way as Silicon Valley Bank? And our general consensus in our shop, this may be overly cynical, is that the answer is probably not. At least it's very unlikely the depositors would know that they were not going to get haircuts three days after it failed, over a weekend. There's almost no question in my mind that less well-heeled depositors would have had to sweat it out a little bit.

24:25I don't know. I think that my own preference and no one likes to see anyone go out of business. No one wants to see anyone fail. But I feel very strongly that free markets are the best allocators of capital. And with free markets comes the possibility of failure. And because if you don't let people fail, you'll never, when you're talking about Hotel California situation, the Fed will never be able to normalize monetary policy. And so again, it's very unfortunate. No one likes to see it happen, but it's very difficult to have a free market economy without failure. Yeah, and also you have this risk of essentially what happens when you totally stop forest fires, right?

25:12You don't have the ability to burn out some of the lower line kindling. And what happens is you get this massive overgrowth. And then when something does blow up, it blows up at a massive, massive scale. Yeah, I love that metaphor, because I think that's exactly, I think that's precisely right. In some ways, you could say we're kind of close to that now. And then so many of the things that you've tried to accomplish after the global financial crisis, I would argue, one of them being trying to avoid too big to fail. In many ways, right, that's gotten worse, right? You have a certain number of banks that are too bigger to fail, right?

25:48We're hoovering up all the deposits, and then it's becoming, as you mentioned before, a little less American to the extent to which, certainly in Europe or Canada, those banking systems tend to be dominated by a relatively small number of banks. And so, which makes the system somewhat less dynamic, I would argue. So it's unfortunate we're here, but this may be just what we need to get through to progress. And then you wind up in this sort of paradoxical situation where you get a failure like Silicon Valley Bank and you get a joint statement from the Fed, FDIC, and Treasury, essentially backstopping them because what happens if you don't?

26:29I mean, it means everyone who has a banking relationship with one of the GSIBs, the Global Systemically Important Banks, picks up the phone on Monday morning and moves all of their assets there. I mean, that is this weird sort of paradoxical environment of unintended consequences that we seem to have created. Amen. And again, I'm glad I'm not in the Fed's shoes because, to be honest with you, there are no good answers here. I mean, it's a question of which answer is less bad. And so I'm going to, notwithstanding my kind of open-ended question about East Palestine and East Palestine Bank versus Solakon Valley, I'm going to trust them to do the right thing and what they think is the best thing.