First Republic, Third Failure

May 1, 2023

By Ben Norris, CFA, Securities Research Analyst, Associate Vice President
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The mood on Wall Street improved last week as better-than-expected earnings from technology companies and in-line inflation numbers soothed investors’ worst fears. Each of the three major indices finished the week higher despite choppy trading intra-week. The S&P 500 (SPX) and Dow Jones Industrial Average (DJIA) each managed a 0.9% gain while the NASDAQ Composite (COMP) led with a 1.3% advance. Small cap stocks were under pressure once again as investors preferred the safety of larger-cap stocks ahead of economic growth and inflation readings. The Russell 2000 index marked a 1.2% loss. Bonds rallied last week as U.S. Treasury yields moved lower across the curve. Investors are increasingly confident that this week’s Federal Open Market Committee (FOMC) meeting will mark the last time the Fed hikes rates this cycle. The market is projecting a ~90% chance that the Fed will go ahead with a 0.25% hike on Wednesday before pausing their hiking campaign at June’s FOMC meeting. Still, the inversion of the 3-month and 10-year Treasury yields reached its widest spread last week at -1.64%. The 3-month/10-year spread has only been more inverted twice in the last 60 years, and each preceded a recession.

At least some of the reasoning behind a Fed pause after this week is due to progress on inflation and a slowing U.S. economy as measured by Gross Domestic Product (GDP). First quarter GDP growth came in at a +1.1% annualized rate which was a disappointment relative to expectations (+1.9% consensus) and marked a slowdown from the +2.6% annualized growth rate in the fourth quarter. Making the news worse, nearly all the growth was tied to consumer spending, with a 45% annualized increase in auto sales – a number that is unlikely to remain elevated as the year progresses. Government purchases were the other source of growth in the first quarter (+0.8%) which is not as a desirable as growth fueled by business investment which came in at a disappointing +0.1% rate. The report also showed that GDP prices rose at a 4.0% annual rate in the first quarter and are up 5.3% from a year earlier. The weakest component of the report was inventories which detracted 2.3% from the overall GDP growth number. This, paired with the weak business investment number, likely signals that companies are taking steps to prepare for a recession in the coming quarters.

While first quarter GDP was a mixed bag at best, Friday’s Personal Consumption Expenditures (PCE) reading was at least partially encouraging, even if it didn’t show as much progress in the fight against inflation as the Fed would have liked. Headline PCE fell to 4.2% year-over-year, down from 5.1% in the prior reading and significantly lower than the 7.0% peak seen last summer. Core PCE, which excludes food and energy prices, rose 4.6% in March compared to expectations for a 4.5% increase. Core PCE has proven to be much stickier than headline PCE thanks to stubbornly high services inflation. The Fed is now also watching a subset of PCE call “SuperCore” which takes core PCE and also excludes housing costs (services only). SuperCore PCE rose 4.4% versus a year ago, still well above the Fed’s 2% goal.

The same report saw personal incomes rise 6.0% year-over-year, meaning that wage gains are outpacing inflation. While this is positive for consumers, it may be a contributing factor to the sticky inflation mentioned above as more money chasing fewer goods is a recipe for higher prices. Despite personal incomes gaining relative to inflation, consumer confidence fell in April as Americans worry about a weakening job market and lingering concerns around a recession. Much of the remaining economic data released last week could be characterized as contradictory. New home sales surged to a recent high while pending home sales fell sharply. Jobless claims saw an improvement from their prior reading while job openings are expected to contract in the coming weeks as employers prepare to reign in spending.

Nearly 180 companies in SPX reported earnings last week with notable companies like Microsoft, Meta Platforms (formerly Facebook) and Amazon dominating headlines. While first quarter earnings have hit some bumps in the road, they have mostly outperformed low expectations. I don’t think outperforming low expectations means a significant move higher from here, but I do think it helps avoid an extreme bear-case scenario. More than 80% of SPX companies that have reported earnings so far have beaten Wall Street estimates. Earnings growth is flat compared to expectations for a -6% year-over-year decline and revenue is also ahead of forecasts with a 5% gain. Much of the management commentary so far confirms what the economic data is saying, American consumers remain in fairly good shape all things considered. Several major companies are still due to release results in the coming weeks so the hot start could cool, but we’re off to an encouraging start relative to where many strategists thought we would be.

The other major development last week was the deterioration of the situation at First Republic bank. The bank’s stock plummeted as it became clear that its deposit base was quickly evaporating. First Republic’s management team indicated that $100 billion in deposits left in the month of March following the collapse of Silicon Valley Bank. Just over a month ago, a coalition of 11 banks offered a $30 billion lifeline in an effort to stop the spreading panic, but the emergency plan wasn’t enough to stop spooked customers from moving their money elsewhere. Even the Fed’s “Bank Term Funding Program”, which sought to support banks by offering loans against underwater assets at attractive terms (to calm customer fears) wasn’t enough to stop the outflows. Over the weekend the bank finally collapsed, and the Federal Deposit Insurance Corporation (FDIC) took receivership of the bank. Late Sunday it was announced that JPMorgan Chase (JPM) would buy First Republic and assume the majority of its loan book and deposit base. Investors have reacted surprisingly calmly to the collapse given that this is the second largest bank collapse in U.S. history. For the record, three of the four largest U.S. bank failures in history have occurred in the last two months.

JPM, the largest American bank, has said it has received $50 billion in new deposits from customers leaving smaller, more vulnerable banks since March. With the acquisition of First Republic assets, JPM will take on another $170 billion in loans, $30 billion in securities, and $90 billion in deposits. The collapse of First Republic is widely expected to be the last major bank to failure in the current crisis as other banks have taken advantage of the Fed’s emergency measures. As a result, investors will likely look to stronger than expected earnings and the end of the Fed’s hiking cycle as reasons to be optimistic rather than dwell on the past. Still, U.S. banks are expected to be more conservative in their lending decisions in the coming quarter which will undoubtedly have a cooling effect on the economy when paired with the Fed’s current monetary policy.

The FOMC’s policy statement and press conference with Chair Jerome Powell will be the highlight of a busy week of economic data releases. In addition to a variety of employment and economic activity measures, the first quarter earnings season will continue with companies like Apple, Pfizer, Starbucks, and Qualcomm all reporting this week. More than 160 SPX companies share results before the week is over. Finally, investors will continue to digest JPMorgan’s takeover of First Republic as they decide if the worst is over for American banks.

Date Report



Monday 5/1/2023 U.S. Manufacturing PMI (April)



ISM Manufacturing (April)



Tuesday 5/2/2023 U.S. Job Openings (March)



Wednesday 5/3/2023 ADP Employment Report (April)



U.S. Services PMI (April)



ISM Services (April)



FOMC Statement & Chair Powell Press Conference

Thursday 5/4/2023 Initial Jobless Claims



Continuing Jobless Claims


Friday 5/5/2023 U.S. Employment Report



U.S. Unemployment Rate



U.S. Hourly Wages (year-over-year)



Consumer Credit




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