By: Stash Graham
Domestic indices generated broad but slight gains during the month of April. The year’s big winner, the Nasdaq Composite Index, was up 0.2% during the month, while the Dow Jones Industrial Average and S&P 500 outperformed, increasing by 2.5% and 1.5%, respectively. As we will discuss, these headline index returns might be misleading as we see a significant performance divide. Precious metal, gold, gained 0.90% for the month. Interest rates along the yield curve experienced varying increases as market participants are growing concerned that the Federal Reserve might be further behind in the fight against inflation than previously thought.
The month ended with another banking collapse as the FDIC seized First Republic Bank (FRC) and promptly sold most of the bank to J.P. Morgan Chase. The deal will wipe out all portions of FRC’s capital structure (bonds, preferred, and common equity). The FDIC seizures highlight the stress many banks are seeing after a couple of years of mismanagement of their assets. As the Federal Reserve raises the Discount and Fed Funds Rates another 25 basis points this week, banks will come under little more pressure as funding costs continue to increase. If inflation continues to maintain elevated levels, the Federal Reserve might not cut borrowing rates this fall, as market participants expect. These interest rate cuts would be a welcome reprieve for banking executives on profitability and asset fronts. In our quarterly call, we warned about the possible knock-on effects on the broader economy. The U.S. economy is very reliant on ready and available credit. The cost of credit is also significant and has a high, forward-looking correlation with slower residential spending and business investment. In the past 50 years, there have been only two other instances (the 9/11 Terrorist Attacks and Lehman Brothers Bankruptcy) where U.S. banks cut lending as sharply as they did in the four weeks through April 12, according to data from the Federal Reserve Bank of St. Louis.
The lack of breadth in the stock market is eye-opening and concerning. Consider this, the headline S&P 500 year to date is up more than +8%, while the equal-weighted S&P 500 is up just over +1.6%. Just three companies (Apple, Microsoft, and Nvidia) are responsible for over half of the headline S&P 500 move. The separation between small caps and large caps is also very noteworthy. The Russell 2000 used an end-of-month rally to turn barely positive in 2023 (+0.44%). Over the last two years, the Russell 2000 is still down more than -23%. Compared to the headline S&P 500, over the same period, the loss is much less at approximately -1%. The famous saying from legendary Merrill Lynch investing guru Bob Farrell comes to mind, “Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.”
We saw a larger-than-expected drop in the Conference Board’s consumer confidence survey during the month. Consumer confidence fell to 101.3 from a downwardly revised 104 in March. April’s consumer confidence score was materially worse than Bloomberg Economics and industry consensus expectations. In particular, future expectations were the main driver for the fall in survey scores. Consumers were very pessimistic about the near-term future of business conditions and the labor market. The consumer expectations index score of 68.1 is the lowest since the COVID shutdown. Index scores below 80 within the future expectations typically signal an economic recession within a year. The reason for the high correlation is that household consumption levels move with future expectations of income. For example, suppose a prospective consumer is worried about their job. In that case, they will likely pull back on increasing their consumption, whether purchasing a household appliance or taking a family vacation. When supplementing these pessimistic future expectations with variables such as a higher cost of borrowing and the previously mentioned ‘bullwhip effect,’ it is fair to assume that consumption levels for the rest of the year will remain muted.