This morning, it was a rather light day for economic news. Of note, we did get the final revision to the fourth-quarter Gross Domestic Product (GDP) estimate. That figure was little changed at 2.6%. The core pricing index came in at 4.4%, which was revised modestly higher. Meantime, initial unemployment claims for the week ending March 25th came in at 198,000 which was up modestly from the previous-week tally (191,000), but still indicative of a tight labor market. The equity futures are higher on easing banking industry concerns (at least for the moment) and were little changed after the economic releases.
The penultimate day of March will begin with the Dow Jones Industrial Average and the broader S&P 500 index little moved from where they began the month. The modest gains, though, did not mean that it was a quiet month for the major averages. On the contrary, it has been a very volatile stretch for the U.S. equity and bond markets, with the major indexes seesawing on banking and economic news, and the latest Federal Reserve monetary policy decision (issued last week). These events have created a lot of uncertainty on Wall Street, which is likely behind the recent broader market volatility.
The major equity averages put in a good performance yesterday, fueled, in large part, by sentiment that the recent struggles in the banking system may be contained, and fears of a contagion fading a bit. This sentiment raised the appetite for riskier assets on Wall Street, and we again saw some movement into the higher-growth technology sector, with increased interest in the mega-cap technology companies. The recent decision by the Federal Reserve to raise the benchmark short-term interest rate by only a quarter point, to 4.75%-5.00%, and growing sentiment that the central bank may pause on the rate-hike front at the next meeting so as not to pressure an already shaky regional banking system, are giving a boost to the higher-growth technology names. This also has helped the NASDAQ Composite to produce a month-to-date gain of more than 5% heading into the final two days of trading in March. The increased appetite for risk is hurting the more-defensive stocks in the healthcare and consumer staples sectors.
The banking sector has been in the cross hairs of investors this month. But, as noted, some sentiment that the recent banking crisis may be easing is driving stocks higher. Wall Street was encouraged by the quick and decisive moves from the Federal Reserve, the Federal Deposit Insurance Corporation (FDIC), and the Treasury Department to contain the damage at a few regional banks and not allow it to create a systemic problem. Looking forward, regulators face the task of replenishing funds at the FDIC, and the proceedings on Capitol Hill this week have brought talks that they have to lean on the bigger banks to do so.
We also would caution that most banks are still facing a more onerous lending environment where interest rates remain elevated versus the levels witnessed a few years ago. This is likely to put pressure on future lending. We will get more clarity on the health of the U.S. banking system in a few weeks when first-quarter results are released. Investors will be looking to see which banks have increased their loan loss provisions, which are funds set aside to protect against loan defaults. One thing the recent struggles in the industry may do is force more banks to lend less, which decreases the money supply and could have an adverse effect on the economy in the coming quarters.
The economic data, save for continued solid readings on employment, have been weakening of late. In addition to ongoing sluggishness in the housing and manufacturing sectors, the consumer is starting to show a hesitation to continue spending loosely on nonessential items. The consumption component of the fourth-quarter GDP figure was revised lower to 1.0%, down from previous estimate of 1.4%. (If savings built up during the pandemic are used on discretionary items, much of it lately is going toward travel and leisure activities.) Both retail sales and durable goods orders fell in February, as consumer credit card balances expanded to record levels, and the borrowing has been done at significantly higher rates than we saw at the start of 2022. This raises concerns about increased defaults in the consumer credit space if the economy heads into a recession in the coming months.
Likewise, there also are increasing worries about a crisis emerging in the commercial real estate market, where higher lending rates and a shift in geographic demographics are weighing on the profits of many of the bigger industry players in the Real Estate Investment Trust (REIT) Industry. We would proceed with extra caution when considering a commitment in the commercial REIT space. REIT stocks were under pressure yesterday on these escalating concerns.
It is also worth noting that when worries about economic growth rise, investors tend to give a closer look at the higher-growth sectors, most notably technology. This, along with a sharp drop in Treasury market yields last week (though they have recovered some in recent sessions), is likely behind the recent interest in technology, which is the best-performing sector year to date. Much like during the early stages of the COVID-19 pandemic, investors are viewing the tech names as a defensive hedge against the impact of a slowing economy. – William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
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