- There were big inflation reports during the week, but most of the market’s attention was on the continuing drama surrounding several bank failures and what the resolutions might be to avoid further damage. One of the latest actions was a group of the largest U.S. banks, supported by the U.S. government, coming together to rescue the troubled First Republic Bank.
- The bank turmoil has resulted in the Financials sector being down more than -10% so far in March. Yet, despite the banking-induced pullback, the S&P 500 Index and Nasdaq Composite were able to post decent gains for the week.
- Bond volatility has spiked from the banking trouble and the yield on the 2-year U.S. Treasury yield plunged -75 basis points (bps) over the week, from 4.59% to 3.84%, which was the largest weekly decline since 1987.
Banking stress persists, and short-term bonds soar
Normally a week loaded with inflation data like the CPI, PPI, and Import Prices would command most of the attention, but it was the banking sector that was primarily in focus this week as more banks face failure. The turbulence that originated with the prior week’s failures of SVB Financial Group, crypto-related Silvergate Capital, and Signature Bank, continued this past week as eleven large U.S. banks joined together in an attempt, supported by the U.S. government, to stabilize First Republic Bank. And the turbulence extended overseas as Credit Suisse Group also sought assistance to shore up its capital, announcing that it will borrow $54 billion from the Swiss National Bank—although reports over the weekend say it is also in talks with UBS to take overall or part of it.
The bank turmoil has resulted in the Financials sector being down more than -10% so far in March. Yet, despite the banking-induced pullback, the S&P 500 Index and Nasdaq Composite were able to post decent gains for the week. The S&P 500 gained +1.4% and the Nasdaq Composite advanced +4.4%. Smaller companies weren’t as fortunate, as the Russell 2000 Index sank -2.6%, sinking it into negative territory for 2023 (-2.0%). The Russell 2000 is about 16% financials versus about 13% for the S&P 500, and also has more than 40% of its constituents that are cash flow negative, a double whammy in this market environment. Developed market international stocks also struggled, with the MSCI EAFE Index falling -3.2%—it’s comprised of about 19% financials. Emerging market stocks fared a little better, but still ended down with the MSCI Emerging Markets Index slipping -0.4%.
The real action during the week was in the bond world, where the MOVE Index (a gauge of U.S. Treasury bond volatility) spiked nearly +30% during the week. The banking fears have resulted in a heavy flight to quality, which combined with heavy short-covering by hedge fund and momentum traders, resulted in the 2-year U.S. Treasury yield plunging -75 basis points (bps) for the week, from 4.59% to 3.84%, which was the largest weekly decline since 1987. As a result, the Bloomberg U.S. Aggregate Bond Index rose +1.4%, its best week since January 6. Overseas, the European Central Bank (ECB) hiked rates by 50 basis points despite the banking turmoil, raising the key deposit rate from 2.5% to 3.0%—its highest level since 2008. Still, the Bloomberg Global Aggregate Bond Index ex U.S. (the benchmark for non-U.S. bonds) was able to advance +1.9% for its best week since January 13.
It all sets up for another potentially eventful week, as the banking turmoil will likely remain in the headlines, to be joined by the outcome of the Federal Reserve’s rate decision on Wednesday, as well as housing and a handful of economic activity reports throughout the week.
Chart of the Week
The Conference Board’s Leading Economic Index (LEI) fell -0.3% in February, in line with expectations and January’s unrevised drop. The index recorded its eleventh consecutive monthly loss, the longest losing streak since the ‘Lehman Crisis’ when it fell 22 straight months from June 2007 to April 2008. Although the pace of the declines have been more moderate in the last two months, the results remain robust with eight of the ten indicators down in February. As shown in the chart below, the year-over-year change continued to decline into recessionary territory, which has historically led to Gross Domestic Product (GDP) declines.
LEIs Point to Decelerating GDP, Recession
LEI and GDP Year-over-Year change (%)
Source: The Conference Board, Bureau of Economic Analysis (BEA)
- The Consumer Price Index (CPI) rose +0.4% in the month of February, in line with expectations, and down from +0.5% in January (unrevised). Year-over-year, consumer prices were up +6.0%, also matching expectations, and down from an unrevised +6.4% in January. Core CPI, which excludes the more volatile food and energy prices, was up +0.5% for the month, slightly above expectations, and January’s unrevised rate, which were both +0.4%. Core CPI was up +5.5% year-over-year, in line with expectations and slightly below January’s unadjusted +5.6% rise.
- The Producer Price Index (PPI) dipped -0.1% in February, well below expectations of a +0.3% gain, and following January’s downwardly revised +0.3% increase. Year-over-year saw wholesale inflation up +4.6%, below expectations of +5.4%, and compared to the prior month’s downwardly adjusted 5.7% rise. Core PPI—excludes food and energy—was unchanged for the month, below expectations of +0.4%, and the prior month’s negatively revised +0.1%. Core PPI was up 4.4% year-over-year, below expectations of +5.2% and January’s negatively revised +5.0%.
- The Import Price Index slid -0.1% in February, higher than expectations of -0.2%, and January’s downwardly revised -0.4%. Year-over-year, prices were down -1.1%, matching expectations and down from January’s upwardly revised +0.9%.
- Advance Retail Sales fell -0.4% in February, matching expectations and well below January’s upwardly revised +3.2% surge. Retail sales ex-autos slid -0.1% for the month, in line with expectations and below January’s positively revised +2.4%. Sales ex-autos and gas were unchanged, above expectations for a -0.2% fall, but far below January’s positively revised +2.8%. The Control Group, a figure used to calculate GDP, increased +0.5%, well above expectations of +0.3%, but far below January’s positively revised +2.3% gain.
- The Federal Reserve reported that February Industrial Production was unchanged, below expectations for +0.2% and January’s positively revised +0.3%. Manufacturing output was up, offset by a drop in mining and utility production. Capacity Utilization was also unchanged from the prior month’s negatively revised 78.0%, below expectations for a slight increase to 78.4%.
- The National Federation of Independent Business (NFIB) Small Business Optimism Index increased to 90.9 in February, up from 90.3 in January. According to the report, 28% of small business owners noted that inflation was their single most important problem in operating their business.
- The preliminary University of Michigan Consumer Sentiment Index for March fell to 63.4 from February’s final reading of 67.0 where it was expected to remain. A drop in the Current Conditions portion of the index joined a slip in the Expectations component of the report. The 1-year inflation forecast fell to 3.8% from 4.1% in February, and the 5-10-year inflation outlook was down to 2.8% from 2.9% the prior month.
- The Empire State Manufacturing Index, a measure of activity in the New York region, fell further in contraction territory (a reading below zero) in March, plunging to -24.6 from -5.8 in February, well below expectations for a drop to -7.9.
- The March Philly Fed Manufacturing Business Outlook Index improved but remained well into contraction territory (a reading below zero), increasing to -23.2 from -24.3 in February, far worse than expectations for -15.0.
- Housing Starts rose +9.8% in February, hitting an annual pace of 1,450,000 units, versus expectations for a slight increase to a 1,310,000-unit pace from January’s upwardly revised 1,321,000-unit level. Building Permits, one of the leading indicators tracked by the Conference Board, jumped +13.8% to an annual rate of 1,524,000, well above expectations of 1,343,000 units and the unrevised 1,339,000 units in January.
- The National Association of Home Builders (NAHB) Housing Market Index (HMI) showed homebuilder sentiment unexpectedly improved in March, rising to 44, above expectations for a decline to 40 and February’s unrevised 42. Despite the unexpected improvement, this was the eighth-straight month that homebuilder sentiment was below 50—which suggests poor conditions.
- The weekly MBA Mortgage Application Index rose +6.5%, the second week of solid gains after the prior week’s +7.4% increase, as the Refinance Index rose +4.8% and the Purchase Index was up +7.3%. The increase came as the average 30-year mortgage rate fell 8 basis points to 6.71%, which is up 2.44 percentage points versus a year ago.
- Weekly Initial Jobless Claims fell by -20,000 to 192,000 for the week ended March 11, under expectations for 205,000 and the prior week’s upwardly revised 212,000. Continuing Claims for the week ended March 4 fell by -29,000 to 1,684,000, under expectations of 1,723,000.
The Week Ahead
The coming week’s economic calendar is on the lighter side this week, but it does include some key releases. Chief among those is the Federal Open Market Committee’s (FOMC) rate hike decision set for Wednesday, March 22. A big question will be whether the stress in the banking sector will impact the FOMC’s rate hike campaign, and markets have settled in on expectations for a 25-bp rate hike. Housing data is due with existing home sales and new home sales reports, as well as the weekly MBA Mortgage Applications. Other reports slated for release include the Chicago Fed National Activity Index, Kansas City Fed Manufacturing Index, preliminary reads on durable goods orders, as well as March manufacturing and services activity from S&P Global.
Did You Know?
INVERSION PERVERSION – After U.S. Federal Reserve Chair Powell suggested that interest rates may have to rise more than the Fed expected, the 2s/10s yield curve (the difference between yields for the 2-Year and 10-Year U.S. Treasuries) dropped to its most negative (inverted) levels since September 1981. Since 1977, the only period where the yield curve was as much or more inverted was in a two-year stretch from October 1979 to September 1981. However, just since last week, the 2s/10s yield curve has been more than cut in half from that historic negative level as a result of the “flight to safety” in the wake of the banking stress (source: Bespoke Investment Group).
OVERCONFIDENT – In a recent J.D. Power survey of more than 4,000 banking consumers, 58% said they do not have any significant doubts about their own level of financial literacy. However, when survey takers were later asked three key questions to test their individual financial knowledge, only 37% answered all three questions correctly (source: J.K. Power, MFS).
BRACKETOLOGY – Despite the “distraction” of the first round of the Men’s NCAA basketball tournament on Thursdays and Fridays during this past week every March, stock market volume has usually been above average on the two trading days. Over the last 20 years, volume in the S&P 500 ETF (SPY) has been above its 50-day moving average 60% of the time on day one of the first round and 70% of the time on day two (source: Bespoke Investment Group, MFS).
This Week in History
NEW MEMBERS – On March 17 in 1997, Walmart, Johnson & Johnson, Travelers Companies, and Hewlett Packard Enterprise joined the Dow Jones Industrial Average in an attempt to update the index membership from an old industrial-based economy to a modern tech- and healthcare-oriented economy. The four new additions replaced Westinghouse Electric, Texaco, Bethlehem Steel, and Woolworth. Westinghouse, Bethlehem, and Woolworth were original Dow components (source: Benzinga).
Asset Class Performance
The Importance of Diversification. Diversification mitigates the risk of relying on any single investment and offers a host of long-term benefits, such as lowering portfolio volatility, improving risk-adjusted returns, and helping investments to compound more effectively.
Asset‐class performance is presented by using market returns from an exchange‐traded fund (ETF) proxy that best represents its respective broad asset class. Returns shown are net of fund fees for and do not necessarily represent performance of specific mutual funds and/or exchange-traded funds recommended by The Retirement Planning Group. The performance of those funds may be substantially different than the performance of the broad asset classes and to proxy ETFs represented here. U.S. Bonds (iShares Core U.S. Aggregate Bond ETF); High‐Yield Bond (iShares iBoxx $ High Yield Corporate Bond ETF); Intl Bonds (SPDR® Bloomberg Barclays International Corporate Bond ETF); Large Growth (iShares Russell 1000 Growth ETF); Large Value (iShares Russell 1000 Value ETF); Mid Growth (iShares Russell Mid-Cap Growth ETF); Mid Value (iShares Russell Mid-Cap Value ETF); Small Growth (iShares Russell 2000 Growth ETF); Small Value (iShares Russell 2000 Value ETF); Intl Equity (iShares MSCI EAFE ETF); Emg Markets (iShares MSCI Emerging Markets ETF); and Real Estate (iShares U.S. Real Estate ETF). The return displayed as “Allocation” is a weighted average of the ETF proxies shown as represented by 30% U.S. Bonds, 5% International Bonds, 5% High Yield Bonds, 10% Large Growth, 10% Large Value, 4% Mid Growth, 4% Mid Value, 2% Small Growth, 2% Small Value, 18% International Stock, 7% Emerging Markets, 3% Real Estate.
* The term basis points (bps) refers to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 0.01%. Bond prices and bond yields are inversely related. As the price of a bond goes up, the yield decreases.