Some important thoughts from the head of Goldman hedge fund coverage, Tony Pasquariello
Following five days of extraordinary price action — and headed into today’s quarterly expiry — five quick takes and three charts:
1. Point-to-point, the equity market has largely treated the recent events as a surgical strike on a specific cohort of stocks. Don’t take my word for it: compared to last Thursday at 4:15 PM, S&P futures are net positive and NDX is … 5% higher. When coupled with the additional fact that implied volatility is nearly unchanged from where it was marked before this storm hit, again the pattern suggests the market has mostly compartmentalized, if cauterized, stresses in the banking sector. I find that a bit remarkable, especially when you confront the inconvenient truth that central banks are in a very different position today than they were in during past financial shocks. With that on the table, I will note that we’re only five trading days into a new chapter — and, as detailed below, I believe the balance of risks are shifting to the downside.
2. US regional banks: To my eye, now this is less a story of creditworthiness, and more a story of the degradation of forward earnings power. At current levels, one can argue that’s largely in the price of these stocks. Looking further ahead, however, it’s hard to not be concerned around the medium-term availability of bank lending into the real economy. This is a new challenge and the impulse for financial conditions — broadly defined in a practical sense — is likely to worsen. Instinctively, it’s very hard for me to see how this impingement of credit availability isn’t problematic for the heart of the US economy. For further reading from the in-house experts: link
3. The question that’s come up over and over since last week is how to calibrate the regional bank issue into units of GDP. our US economics team did the hard work, and this is the punch line (link):
- Small and medium-sized banks play an important role in the US economy. Banks with less than $250bn in assets account for roughly 50% of US commercial and industrial lending, 60% of residential real estate lending, 80% of commercial real estate lending, and 45% of consumer lending.
- The macroeconomic impact of a pullback in lending will remain highly uncertain until the extent of the stress on the banking system becomes clear.
- We estimate it using two approaches:
- Our accounting approach assumes that small banks with a low share of FDIC-covered deposits reduce new lending by 40% and other small banks reduce new lending by 15%.
- This implies a 2.5% drag on the total stock of bank lending, which economics studies suggest would result in a roughly ¼ pp drag on 2023 GDP growth.
- Our statistical approach expands our financial conditions growth impulse model to include bank lending standards, which we assume will tighten substantially further, and implies a drag on GDP growth of ½ pp beyond that already implied by the lagged impact of the tightening in recent quarters. We have lowered our 2023 Q4/Q4 GDP growth forecast by 0.3pp to 1.2% to incorporate these estimates of tighter lending standards, reflecting in part a larger downgrade to investment spending.
What of the Fed? We can debate its local relevancy given everything else that’s happening, but CPI didn’t cement expectations for next week. The good news is headline has fallen for eight consecutive months; the bad news is 5.5% on core is still a long ways from target. to be clear: US inflation is still a serious issue and it’s not coming down as fast as most expected (particularly is it relates to “super core”). for next week’s FOMC, I will leave the handicapping to the experts, but assume the Fed will deliver whatever the rate market is pricing into the event (currently a ~ 75% probability of a 25 bps hike). two attendant points:
- If you’re looking for an analog on how a central bank attempts to manage a local crisis while maintaining a hiking cycle, turn your history book to chapter on the BOE in October … link.
- After a month of terrible NYC weather, the mind wanders a bit to the prospect of warmer days. at which point the mind further wanders to what will the Fed be doing this summer — hiking, pausing or cutting? I can’t remember a time when each distinct scenario carried reasonable near-term delta.
5. With all of that thrown into the blender, here’s my general take on market direction:
- i. In a tactical context, price action determines sentiment and narrative. Given the velocity of the past few weeks, most folks in the levered community were exceptionally negative on equity risk (this is an anecdotal observation that’s vindicated by GS PB data and franchise flows). When taken together with the truly stunning drop in front end yields, there was kindling for the type of short-term, counter-sentiment rally that we’ve seen this week. I’m not saying this is a recipe for lasting strength — not at all — rather, it fits the classic profile. remember, S&P closed HIGHER the immediate week after LEH fell (in another sense where history rhymes, recall the ECB hiked just one month prior to that).
- ii. Beyond that, my view is S&P will trade 5-10% lower over the next six months along a choppy path. Going back to square one: I had a hard time paying 18x for 0% expected earnings growth …and that was before the foundation revealed a genuine crack. again, the upside tail seems very constrained — either the regional banking story subsides and the Fed needs to keep chopping wood, or the regional banking story doesn’t subside and we lurch from issue to issue (as we saw in Europe this week). more locally, flow-of-funds looks to be more of a headwind than a tailwind given a tapering of corporate demand and an acceleration of non-discretionary supply.
- iii. If I’m wrong on the downside call, I suspect it’s because we’ll get through the next few weeks without another banking firestorm, but the Fed loses their nerve and downshifts anyway. Note the modern day history book of Fed pauses is very friendly for stocks (with the notable exception of 2000-02, which also rhymes).
- iv. No matter what happens, I have a hard time disagreeing with an up-in-quality bias. This plan wasn’t working for most of this year, but a switch was flipped this past week. mega cap tech could be a primary beneficiary of this; note NDX has outperformed S&P for … 11 straight days.
- v. In the context of the possible distribution of forward returns, implied volatility feels instinctively cheap to me, and put-call skew looks undemanding to me.
* * *
i. This is the showstopper … a plot of the 5-day rate of change of US interest rate implied volatility … again, I find it incredible that stocks haven’t been more intimidated by this.
ii. The ratio of weak balance sheet stocks over strong balance sheet stocks … I don’t have an MBA, but I reckon the cost of capital will be going up from here as credit provision becomes harder to come by:
iii. The ratio of cyclical companies over defensive companies … if you’re worried about long and variable lags, you should be selling this pair
More in the full note available to pro subs.
Fri, 03/17/2023 – 16:40
Click this link for the original source of this article.
Author: Tyler Durden
This content is courtesy of, and owned and copyrighted by, https://zerohedge.com and its author. This content is made available by use of the public RSS feed offered by the host site and is used for educational purposes only. If you are the author or represent the host site and would like this content removed now and in the future, please contact USSANews.com using the email address in the Contact page found in the website menu.