It’s All Good?

It’s All Good?

For whatever reason, investors are awfully complacent. Maybe I’m being too negative, but panic has to start from somewhere. I suppose it shouldn’t be too shocking that we’ve held up, as investor sentiment is still pretty strong, and it can take quite a while to change that. The Great Recession was pretty bad, but investors were very slow to recognize the extent of the problems. There were several times where investors thought all the problems were behind us, or the Fed would save us. Game of Trades has a nice chart of that experience:

The thing is, I think there are a lot of potential triggers for short-term trouble. That doesn’t mean anything really has to happen, just that we have a combination of volatility events and complacency that could spell trouble.

What are some of the potential issues? Earnings season is starting in earnest this week, and while the quarter should have largely been OK, bank stress caused it to end on a down note. Will that leak into guidance? As an aside, it was interesting to see investors celebrate bank earnings on Friday. Maybe they should’ve said big banks, as the Regional Banking ETF (KRE) finished down 2%.

To stick with banking for a bit, these credit events can take some time to play out, as the chart above shows. We haven’t fixed the core problem of deposit flight, and the logical answer, raising deposit rates, would hit bank earnings hard. While deposit flight took a bit of a break last week, small bank lending has been falling sharply. All these companies that have lived off of cheap, abundant capital are in for a surprise when they need financing, as this is a problem that’s unlikely to go away quickly.

It’s also worth noting that we’re back to a market that’s dominated by the performance of a handful of tech stocks. Further, a lot of these tech companies have seen dropping earnings that have made them more expensive than they were at the start of 2022. If large tech gives way, that can really hit the market.

We’ve also started to see a bit more weakness on the economic front. For instance, while it’s nothing huge, jobless claims are finally starting to trend up. That gets us closer to recession, which historically is tough on stock prices.

We’re also starting to see the leading edge of debt ceiling woes. 1-month T-bills are trading at a good premium to longer-dated bills as people get nervous about getting paid. The Treasury General Account doesn’t currently have enough money to support a month of normal operation, but they should get a slug of money from Tax Day. That’s not been good news for the market, though, as it’s removing money from the economy. In general, money management from the Treasury is sending more money to the RRP, which is also considered a negative for liquidity.

Despite potential problems, the volatility index is near YTD lows. The market hasn’t been very volatile, and has crept up to its downtrend line, so it’s been quiet. There also seem to be a lot of short puts in the market, which also dampen volatility. How long can this low volatility environment last? That’s hard to say, as it’s hard to know just what ends up shaking this market out of the calm. Could it be earnings? World events? OpEx on Friday?

Whatever the case, with the broad market up so much into risk events, I find it hard to get too excited. We’ll see what happens as we approach the next Fed meeting and likely rate hike in early May.