A sense of stability has returned to the markets in the last few days, as share prices of regional banks rebounded. We do see the combination of measures taken by the Fed and other policymakers as helpful in safeguarding the banking sector. With financials – representing 13% of the S&P 500 Index – now in a more stable spot, the broader market should also benefit.1 And while a credit slowdown is typically not good for the economy (see our view here), it works for curtailing inflation. We see this, combined with our view of a Fed pause, as positive for markets. With bearish positioning, a de-risked earnings bar, and strong seasonality, we see a compelling backdrop for risk assets in April. Indeed, in the past 30 years, the S&P 500 has historically been positive 76% of the time in April with a median monthly return north of 1%.2
Measures to Guard the Banking Sector
Steps were taken in recent weeks to help stabilize the banking sector. First, the de facto Fed pause and market implied rate cuts may help alleviate further pressures on deposit outflows, as the 2-year U.S. Treasuries yield moved from north of 5% in early March to around 4% today.3 Secondly, despite last week’s debate about whether or not all uninsured deposits are safe, consensus is emerging among regulators around safeguarding all deposits. The government recently announced it is studying ways to temporarily expand FDIC coverage to all deposits.4 These steps should help alleviate deposit concern. When the weekly commercial banks report is released this Friday, we will be able to determine if deposit outflows from small regional banks have stabilized. We suspect these banks abated from the speed of outflows during the prior week.
The last step in stabilizing the sector was seen in the availability of and usage by banks of the Fed’s lending facilities; thanks to the discount window, banks are now able to shore up their balance sheets with liquidity in the event of more outflows.
Given that the banking turmoil was a liquidity and confidence issue, rather than a solvency and capital adequacy issue, these steps were designed to reassure depositors and restore confidence in the banking sector.
Reduced Positioning Across Many Investors
With a semblance of stability returning, the S&P 500 has moved right above the key level of 4000.5 This is a key technical level and a threshold for systematic investors such as commodity trading advisors (CTAs). As the index traded below 4,000 for most of March, these investors have de-risked their equity exposure. In fact, no matter where you look, investors have reduced their positions. CTAs reduced U.S. equities exposure to the lowest levels since 2019 and 2016, which is on par with the low of late 2022.6 Based on hedge funds and mutual funds beta to the S&P 500, these investors also reduced their exposure to the S&P 500.7 But should the markets indeed be supported by the Fed pause, slowing inflation, and the safeguarding of the banking sector, all of these extremely low positions may need to reset higher. We expect performance chasing from the underweight investors could amplify the moves.
For example, given the low net positions, CTAs would have more to buy in the event of a market upturn than sell in a downturn.8
A Low Earnings Bar and Better Than Expected Economy
But what about fundamentals – shouldn’t we worry about the earnings season for the first quarter of 2023? In our view, the first quarter of 2023 earnings expectations have been well de-risked. Analysts cut earnings per share (EPS) growth estimates by close to 6%, expecting a decline of -6.1% for the quarter; this compares to the average cut of -3%.9 Earnings estimates for Technology and Communication Services were one of the significant drivers of these cuts. Negative guidance and pre-announcements for the first quarter of 2023 are above recent averages.10
But while the consensus was cutting earnings estimates, the economic data was picking up. At the start of the quarter, the consensus was GDP growth for the first quarter of 2023 would be roughly flat which compares to the consensus of +0.6% GDP growth expectation today. However, recent economic data suggests upside to the current GDP consensus estimates with the Atlanta Fed GDPNow nowcast estimate tracking +3.2% GDP growth.11
A Barbell of Tech and Dividends
As we wrote here, Nasdaq stocks are likely to be the key beneficiaries of the Fed’s pause. Additionally, tech and growth are exactly what investors have been chasing lately. In addition to low positions in the S&P 500, mutual funds have an almost 6% underweight to big tech.12 And while hedge funds have been adding to tech as of late, they are still underweight by roughly 2% to this group.13
Finally, deal confidence also seems to be returning and that could help the sector valuations. For example, software VC investment activity is up +24% quarter-over-quarter in the first quarter of 2023.14 And U.S. mergers and acquisitions deals are +62% quarter-over-quarter, which is also boosting sentiment.15 Within tech, software earnings estimates for 2023 have been cut back significantly.16 And in semiconductors, demand for inventories are near all-time highs and shipments are tracking lower, but there is a big dispersion.17 Outside of memory there are pockets of strength in the beneficiaries of the secular shift to cloud and Artificial Intelligence (AI) as their average sales prices (ASP) are holding up well.
We’d balance this higher beta tech idea with a more defensive one. Dividend paying stocks have been hit hard, down close to 10% off early February highs.18 This was particularly due to the exposure to financials within some dividend strategy ETFs. For example, the iShares Select Dividend ETF, which tracks the Dow Jones Select Dividend Index, has a 22% exposure to financials, including regional banks.19 However, even with some stability returning to the banking sector, the economic environment is still uncertain. And if amidst this uncertainty dividend paying stocks can help investors earn close to 4% in yield, this is an opportunity we like.20
1. Source: Bloomberg, iCapital Investment Strategy, as of March 28, 2023.
2. Source: Bloomberg, iCapital Investment Strategy, as of March 28, 2023.
3. Source: Bloomberg, iCapital Investment Strategy, as of March 28, 2023.
4. Source: Bloomberg “US Studies Ways to Insure All Bank Deposits If Crisis Grows” iCapital Investment Strategy, as of March 21, 2023.
5. Source: Bloomberg, iCapital Investment Strategy, as of March 28, 2023.
6. Source: Goldman Sachs FICC and Equities, as of March 23, 2023.
7. Source: Bloomberg, iCapital Investment Strategy, as of March 28, 2023.
8. Source: Goldman Sachs FICC and Equities, as of March 23, 2023.
9. Source: Factset, iCapital Investment Strategy, as of March 16, 2023.
10. Source: Factset, iCapital Investment Strategy, as of March 16, 2023.
11. Source: Bloomberg, Federal Reserve of Atlanta, iCapital Investment Strategy, as of March 24, 2023.
12. Source: Goldman Sachs, as of December 31, 2022. Note: Big Tech includes Alphabet, Apple, Amazon, Meta, Microsoft, Nvidia, and Tesla.
13. Source: Goldman Sachs Prime Book, as of March 24, 2023.
14. Source: Pitchbook, as of March 22, 2023.
15. Source: Pitchbook, as of March 22, 2023.
16. Source: Bloomberg, iCapital Investment Strategy, as of March 28, 2023.
17. Source: Bloomberg, Goldman Sachs, Morgan Stanley, iCapital Investment Strategy, as of March 28, 2023.
18. Source: Bloomberg, iCapital Investment Strategy, as of March 28, 2023.
19. Source: Bloomberg, iCapital Investment Strategy, as of March 28, 2023.
20. Source: Bloomberg, iCapital Investment Strategy, as of March 28, 2023.
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