Investors around the world are scrambling to measure the breadth of the U.S. bank crisis and its impact on domestic growth, as lenders tighten conditions for new loans and consumers pare back spending amid a predicted economic downturn.
The broader market direction, however, has proven far more difficult to assess. Stocks have held at levels seen before Silicon Valley Bank collapsed on March 10 amid hopes that the Treasury's effort to backstop deposits will prove effective. And bond yields have pared moves to the upside as expectations that the Federal Reserve would further boost interest rates have been reset.
CME Group's FedWatch, in fact, suggests at least a 43.7% chance of a July Fed rate cut, compared with a 43% chance that the Fed will hold its current rate steady at between 4.75% and 5%, as the economy turns sour.
Ultimately, it's anyone's guess as to how tighter credit conditions will affect U.S. economic growth. During a question-and-answer session with the media last week in Washington, Fed Chairman Jerome Powell suggested it could be "the equivalent of a rate hike or perhaps more than that" -- even as he stressed that "it's not possible to make that assessment today with any precision whatsoever."
Tighter Credit Conditions on the Way
However, much like the lag consistent with Fed rate hikes -- economists say rate rises aren't truly felt until around 18 months after they are put in place -- the effect of tighter lending standards, fewer new-loan offerings and the follow-on into business investment and consumer spending may not be evident for some time.
"Whether the likely tightening in credit over the next few months is enough to tip the overall economy into a recession is unclear, but the room for error against our pre-SVB growth forecasts is depressingly small," said Ian Shepherdson of Pantheon Macroeconomics.
"We expect very little growth in final demand through the summer -- notwithstanding the likely Q1 bounce as a result of the extremely mild winter across much of the country -- and it would take little extra downward pressure on businesses and/or consumers to transform a story of flat final demand into a recession."
That leaves investors focused on perhaps the market's best mechanism for discounting near-term growth prospects: corporate earnings.
Collective first-quarter earnings for the S&P 500 are set to fall by around 4.6% from last year, according to Refinitiv data, to a share-weighted $421.8 billion. Profits for the three months ending in June are also expected to decline, with estimates pegging a 3.5% contraction from 2022 levels.
That puts the U.S. market firmly in "earnings recession" territory just as the economy looks set to lose steam thanks to both the blunt of stubbornly high inflation and the likely trickle-down impact from muted bank lending.
Rate Hikes Lag; Credit Crunches Lead
The direct impact on bank earnings, however, could be more immediate: forward price/earnings multiples for regional lenders have fallen to their lowest levels since the early days of the covid pandemic, now pegged at around 7 times. That's while broader financial-sector earnings projections have tumbled by around 10.75% to around 41 times since the Silicon Valley Bank collapse.
S&P Global Market Intelligence data, published Wednesday, notes that financial sector earnings were forecast to grow by around 4.5% over the first quarter prior to the SVB meltdown. That figure has fallen to -7.7%.
Data from Bank of America, in fact, indicate tighter lending standards reduce consumer-loan growth around 10% over a three-year period but begin to appear within two to three quarters of their implementation.
This could prove crucial for bank profits. That's because many will need to both increase their deposit rates to arrest the record rate of flight from regional banks to larger lenders, while they also face the possibility of higher fees to cover the multibillion-dollar hit the Federal Deposit Insurance Corp. has taken as part of its rescue effort.
Deposits at smaller U.S. banks, defined as those sitting outside the top 25 in terms of asset size, fell by $119 billion to $5.46 trillion over the seven-day period that ended on March 15, according to Fed data.
Some of that flight found its way into larger banks, however, with the data showing deposits at larger institutions rose $67 billion to $10.74 trillion.
While not evident from the Fed data, much of the cash that is leaving smaller banks could be finding its way into money market funds, according to Bank of America's closely-tracked Flow Show report, which suggested an addition of more than $300 billion over the past month, taking the overall tally to a record $5.1 trillion.
Bank profits, meanwhile, are the second-largest contributor to overall S&P 500 earnings, at 18%, just behind the 21% contribution from tech, and their near-term weakness is yet to find its way into first-quarter or full-year projections.
The follow-on impact from tighter lending conditions is also likely to be felt outside the banking sector, as consumer financing slows and spending fades. That will pressure corporate profit margins across the board, adding further downward influence on earnings forecasts.
Tesla Not Immune
Morgan Stanley's Adam Jonas detailed this impact on Tesla (TSLA) earnings earlier this week, noting that "recent events in the global banking world may drive tighter lending standards and may have an adverse impact on financial institutions’ willingness to fund car purchases at the margin."
Jonas says Tesla's goal of a minimum automotive gross margin of 20% over the first three months of the year "may prove difficult to defend in subsequent quarters in the event of continued downward price competition and slowing economic growth following recent events in the global banking sector and knock-on impacts on the consumer."
And with the tech sector leading the way with headline job cuts, investment spending pullbacks and muted near-term outlooks, stocks will find it difficult to gather momentum into the summer months and beyond if the S&P 500's two largest sectors are mired in recession concerns.
"We held a view over the past two years that corporate earnings will be resilient, but this might start changing," JPMorgan strategists said in a recent research report. They noted that U.S. stocks may have reached their "high point" in the first quarter and likely won't make material gains until the Fed steps away from its inflation fight.
"Profit margins are at record, currently much higher than pre-covid, and the pricing power is likely to deteriorate from here," JPMorgan added.
"In a nutshell, we do not expect a fundamental improvement in equities risk-reward until the Fed is advanced with rate cuts."
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