The term “March Madness” was originally used in 1939 to commemorate a high school basketball tournament in Illinois. It was not brought to the NCAA Basketball Tournament until 1982 when sportscaster Brent Musberger used the term while covering the event for CBS. From there the term soon became synonymous with the national tournament, even though the NCAA did not take ownership of it until 2010. When most people hear the term March Madness they probably think of the basketball tournament but the phrase has recently been thrown around when describing the markets.
Equities were mixed in a week dominated by a blizzard of headlines around banking uncertainties. Markets were whipsawed by evolving concerns about the banking industry following the regulatory shutdown of Silicon Valley Bank. Many other banks thought to be at risk of deposit outflows also came under pressure, including many smaller and regional institutions. Banks take deposits and use the money to make loans. Due to the inherent risk in making loans, not all deposits are loaned out so banks are required to maintain a certain amount of capital, generally invested in bonds of government entities. The sharp rise in interest rates over the past year has led to the value of many of the bonds, especially those that are longer dated, being worth much less than their face value. If depositors withdraw deposits, the bank is forced to sell those bonds at a loss, reducing the bank’s capital. If the bank does not maintain a certain level of capital it is closed by regulators.
The stress in the financial sector has caused interest rates to plunge with yields on 2-year U.S. Treasuries falling more than 1% in a week and a half. Yields on 10-year bonds also dropped, but the rate spread in yields between 2-year and 10-year bonds has narrowed considerably after hitting a fresh post-1981 record inversion a week ago. In this atmosphere, expectations for the upcoming Federal Reserve meeting and further interest rate trajectory have become quite volatile.
“Bracket Buster” is a term used when an underdog, or lower seeded team, unexpectedly defeats a higher seeded team in the tournament since the results often knocks out subsequent predictions of a fan’s (or bettor’s) bracket, which they filled out with game predictions. Odds of interest rate hikes by the Federal Reserve have been gyrating since the beginning of the year, with odds having steadily increased for rates to move higher and stay there for longer. However, predictions of future rate increases have significantly changed over the past couple of weeks with the stress in the financial sector.
Even with turmoil in the banking industry and uncertainty ahead, the Federal Reserve likely will approve a quarter-percentage-point interest rate increase, but for the first time in a very long time the action of the Fed is not a foregone conclusion. Rate expectations have been on a rapidly swinging pendulum over the past two weeks, varying from a half-point hike to holding the line and even at one point some talk that the Fed could cut rates. However, a consensus has emerged that Fed Chairman Jerome Powell and his fellow central bankers will want to signal that while they are attuned to the financial sector upheaval, it’s important to continue the fight to bring down inflation. The interest rate increase will likely be accompanied by assurances that there’s no preset path ahead. The outlook could change depending on market behavior in the coming days, but the indication is for the Fed to hike, especially since last week’s Consumer Price Index (CPI) numbers indicated inflation remains sticky at an annual increase of 6%, still well above the Fed’s comfort zone.
The major event of the week will be the crucial two-day meeting of the Federal Reserve. While there is much speculation regarding the outcome, it remains largely unknown, and it may be the post-meeting public comments from Jerome Powell that move markets the most. Somewhat contrary to interest rate hikes, monetary conditions may be loosening with the new Bank Term Funding Program (BTFP) pushing bank borrowing and in some ways undoing the work of the Fed’s Quantitative Tightening (QT) program. Also, bond yields have dropped dramatically over the past several days leading to lower borrowing costs and perhaps providing some economic stimulus. There is a possibility this will provide a tailwind to risk assets, i.e. stocks.
We continue to monitor the situation with the banking sector, but at this time do not think there will be further contagion and deeper economic strain. However, the added stress coupled with continued tightening by the Fed seems to be increasing odds we will experience a hard landing and recession later this year. Our biggest concern remains corporate profit growth. First quarter earnings reports will begin in a few weeks, which is likely to set the tone for the remainder of the year. If earnings estimates were to drop further, it would not bode well for the markets. By the time earnings begin we should also have further clarity and resolution regarding the banking sector.
If you would like to review your portfolio to ensure it is positioned to weather the current madness, do not hesitate to contact us. Do not chance having your retirement dreams busted by unexpected events.
Have a wonderful week!
Nathan Zeller, CFA, CFP®
Chief Investment Strategist
Please contact us if you would like to review your individual financial plan or learn how the TaxSmart™ Retirement Program can help you.
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