May I Cut In?

May 8, 2023

By Pete Biebel, Senior Vice President
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Stocks boogied steeply higher on Thursday and Friday of the previous week but could not sustain that tempo as last week began. The averages dosey-doed higher last Monday morning, rising briefly above their April highs and to very near their February peaks. That set the stage for a potential bullish breakout over the upper bound of the recent trading range. Sadly, those Monday morning highs proved to be the highs of the week. Continuing fears of further contagion among the regional banks, partnered with a less than bullish policy statement from the Fed on Wednesday, tripped up the averages, leading them to stumble lower over the next few days.

Last week, the regional bank stocks had more eye-popping moves than a double-jointed belly dancer. Those twists and turns greatly influenced the overall market through the week. On Tuesday, as shares of several small banks suffered double-digit percentage losses, the S&P Regional Bank Index (KRE) tumbled 6.3%. The broad averages sank in syncopation, losing a bit more than 1% for the day. KRE twerked lower through the first four sessions of the week; it was down as much as 19% for the week at its Thursday morning low. At that point, the index had lost nearly 47% in just the past two months. Not so coincidentally, the major indices also saw their lows of the week that morning.

One theory that gained traction late in the week was that the deposit drain from the small banks had eased considerably and it was actually the gavotting of short-sellers that had been responsible for the most recent weakness in regional bank stock prices. Perhaps as a result of that theory, on Friday morning, many of those beaten down bank stocks galloped higher Gangnam style. KRE rebounded more than 6% on Friday. The major averages in lockstep rallied on Friday as well, gaining between 1.6% and 2.3%.

For the week, the NASDAQ Composite Index (COMP) waltzed to a gain of a mere 0.07%. The S&P 500 Index (SPX), with its Friday rebound, narrowed its loss for the week to 0.80%. The Dow Jones Industrial Average (DJIA) ended the week with a net loss of 1.24%. Only three of the 11S&P sectors managed to eke out gains for the week: Technology (+0.27%), Utilities (+0.07%) and Healthcare (+0.04%). The Financials and Communication Services sectors each lost a bit more than 2.5% last week. The Energy sector brought up the rear, losing 5.76% for the week. Crude oil prices limboed lower from near $77 per barrel on Monday to below $67 a barrel on Wednesday afternoon.

For many months, the stock market has been dancing to the lead of the FOMC interest rate policy. Stocks would rumba higher when the Fed hinted at a more dovish plan and would electric slide lower on any indication of a more hawkish policy. But this two-step is now about as danced-out as the Macarena; the stock market no longer fears any fancy footwork from the Fed as it now knows the Fed will hike its benchmark rate just once more at most. So, if the stock market has gotten a little blasé about the Fed’s moves, what new dance partner might be next to lead the market’s tango?

One issue hanging in limbo is the timing of exactly when the Fed will begin to moonwalk rates lower. The bond market still expects a rate cut could come later this year. At his Wednesday press conference, FOMC Chairman Jerome Powell indicated that he did not believe that a rate cut was likely this year. It is widely believed that any indication that a rate cut could come sooner rather than later would be very bullish for stocks. However, if the Fed is backed into a corner and forced to cut its benchmark rate in the coming months, it will probably be because the economy is showing signs of recession and not because inflation is under control.

Congressional tap dancing around the looming debt ceiling is one possible suitor for the market’s attention. The inaction to date has already caused a bit of a time warp in the Treasury Bill market. But stocks are likely to turn a cold shoulder to the debt ceiling chicken dance unless and until the country is nearing default.

The more likely new dance partner for the stock market is the increasing probability of a credit crunch. The rapid rise in interest rates already had commercial property owners doing pirouettes to refinance maturing loans. And declining property values of office towers in many large cities has exacerbated the squeeze. Now, the shaky and deteriorating health of regional banks greatly increases the potential for lending standards to tighten. Tighter lending standards would not only hinder economic growth, but more restricted access to capital could knock the legs out from under smaller, less financially sound companies. Stock traders will be watching the yield spreads in the junk bond and direct lending markets for signs of stress.

A prospective credit crunch may already be weighing on small cap stocks. The smaller companies are more likely to need financing and their balance sheets are more vulnerable to shocks from sudden increases in financing costs. Where the three major averages have all posted modest net gains over the past five weeks, the Russell 2000 Index of small-cap stocks (RUT) has a net loss of about 2.3%. Where SPX and DJIA are both near the upper end of their year-to-date ranges, and COMP is at the top of its range, RUT was very near its six-month low at its low last Thursday. Small-cap stocks have been deader than disco.

The clear underperformance of smaller stocks has contributed to a concentration of market leadership. In recent weeks we have pointed out that just a couple dozen stocks accounted for all the gain in SPX year-to-date. A recent report from J.P. Morgan noted that, ”…the underlying market breadth by some measures is the weakest ever – narrowest stock leadership in an upmarket since 1990s.” That concentration was driven in part by a flight to the safety of companies with very big balance sheets and very big cash reserves. The recent excitement over artificial intelligence has also been an excuse to bid up the prices of some of the mega-cap tech stocks. Whatever the cause, this extreme concentration of leadership is an unhealthy sign and an omen for market performance in the coming months.

The two biggest weeks of the new earnings season are now behind us. The reported corporate profits to date for the first quarter have come in a little better than expected. Overall, they’re down but down less than expected. Earnings estimates for the S&P 500 companies for 2023 are hovering around $218 per share and the 2024 estimate is holding around $243 per share.

SPX ended last week near 4136, still within easy reach of the February high, but just below the 4150 – 4175 range that has proved to be a significant barrier over the past few months. The two downdrafts the index has had in the past couple weeks have both held at the 4050 level. That level is also roughly where SPX’s 50-day moving average lies. So that level has taken on additional significance from a technical perspective. Breaking below that level would likely result in an acceleration lower.

The CPI and PPI data due to be released this week will be in the market’s spotlight.

Date Report



Monday 5/8/2023 Wholesale Inventories, March, M/M



Tuesday 5/9/2023 NFIB Small Business Optimism Index, April



Wednesday 5/10/2023 Consumer Price Index, April, M/M



CPI ex-Food & Energy, April, M/M



CPI ex-Food & Energy, April, Y/Y



Thursday 5/11/2023 Initial Jobless Claims



Continuing Claims



Producer Price Index, April, M/M



PPI ex-Food & Energy, April, M/M



PPI ex-Food & Energy, April, Y/Y



Friday 5/12/2023 Import Prices, April, M/M



Export Prices, April, M/M



Consumer Sentiment, May




Links to previously published commentaries can be found at Investment Insights/Weekly Market Commentary/Market