The immobile market

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Good morning. Yesterday, Western Alliance Bancorporation announced its deposit levels have continued to recover. That sparked a broad rally in bank shares. Can we declare the banking micro-crisis of 2023 over? Regional bank indices are still off by 25 per cent since Silicon Valley stumbled in March. But it seems that we are through the acute phase, at the very least. Disagree? Email us: [email protected] and [email protected].
Also, listen to Katie Martin and Harriet Agnew on why no one wants to list in London.
The S&P 500 is where it was 45 days ago and volatility is missing in action. Since the start of April, there have been just six trading days where the S&P has risen or fallen more than 1 per cent, including yesterday, and zero days with a 2 per cent move in any direction.
What gives? The trivial answer: the forces tugging US stocks up are, roughly, equal and opposite to those pushing stocks down. In a recent note, Citi trading strategist Stuart Kaiser offers a more substantive answer. He identifies four countervailing forces pushing in each direction. Those pushing stocks up are:
Many funds have already offloaded risk. In other words, a lot of selling has already happened. Kaiser points out that US large-cap mutual funds ended 2022 with the lowest average beta (ie, generic market exposure) in at least a decade.
Having de-risked, investors are sitting on a lot of cash. This, too, suggests selling has already occurred. Portfolios can be easily rebalanced back towards equities, should opportunities arise. The chart below shows cash allocations in the latest Bank of America fund manager survey, which are still high but have fallen since late 2022. The drop has coincided with this year’s AI hype rally. That is probably not a coincidence.
Investors bought lots of protection, guarding against forced selling. The Cboe Skew index captures investor demand for downside hedges, based on the pricing of out-of-the-money options. As the chart below shows, the Skew index is well above longer-term averages. Demand for protection remains high relative to history, and that, Kaiser argues, means fewer investors forced to sell by a surprise lurch lower:
Systematic funds that buy when volatility is low are pumping money into the market. As the FT’s Nicholas Megaw has reported, quants are playing a powerful role in this market. The main culprits are “volatility control” funds, whose mandates focus on a volatility target, rather than a returns target. When vol is high, they sell; when it is low, they buy. This, alongside share buybacks, has lent the market a steady source of demand. Nomura estimates the purchases at $72bn over the past three months; for context, daily S&P 500 buyback demand is about $4bn-$5bn per day, according to Citi.
The forces weighing down on stocks are more familiar:
‘Tina’ is dead; there are alternatives. Equities need a lot more upside now to impress and, with the arguable exception of tech stocks, few segments look like they can deliver. As one portfolio manager told us yesterday: “From hedge funds to private banks and retail, my clients are all telling me: Why do I need to own equities? Treasuries are at 4 per cent. I hit that bid all day. I can get as much risk-reward living within fixed income, without needing to consider equities.”
Stock valuations aren’t terribly enticing anyway. Standard p/e’s are slightly above historical averages, the Shiller cyclically adjusted p/e ratio is very high and the equity risk premium is near a decade low. If there is a valuation metric that makes the market look cheap, we haven’t seen it.
Risks to growth and corporate earnings are ever-present. Unhedged can’t stop writing about them. Bottom-up analyst earnings estimates are still for modest 2 per cent EPS growth this year and a return to strong growth in 2024:
Options dealers may be selling shares in bulk. Based on option open interest, Kaiser suspects dealers may be holding large inventories of call options expiring between now and the end of June. If that’s right, dealers hedging that inventory would be selling stock into the market, though Kaiser added in an interview that this is “our impression based on conversations with clients” and could be a “wild card”.
The punchline here is that stocks are paralysed, needing a hard shove to start moving decisively. So what might unstick stocks? A debt-ceiling disaster or much worse economic data could well restart the bear market. On the upside, it’s tough for us to see what might do the trick. Kaiser imagines a soft landing and dovish Federal Reserve pivot could drive up equities by “creating a Fomo moment”. Maybe so; as we wrote last week, the soft-landing dream has not died yet. But in the meantime, there is much else to fear besides missing out. (Ethan Wu)
Last week the Federal Deposit Insurance Corporation proposed a special assessment on banks, designed to recover the costs of protecting uninsured depositors in the failures of Silicon Valley Bank and Signature Bank. The assessment would make the banks that benefited the most from the protection of uninsured depositors — that is, those with the most uninsured deposits — pay the most.
It would work like this: banks will pay the equivalent of 12 basis points of all uninsured deposits over $5bn each year for two years, with payments coming quarterly. How big a hit to earnings and capital is this? The FDIC says:
Assuming that the effects on capital and income of the entire amount of the special assessment would occur in one quarter only, it is estimated to result in an average one-quarter reduction in income of 17.5 per cent
Banks that had a lot of uninsured deposits at the end of 2022 (the balance sheet date on which the assessment is to be calculated) would take a somewhat bigger hit. Take Comerica for example, which had $45bn in uninsured deposits as of December 22. That puts its proposed fee at $97mn over two years — 1.6 per cent of its current equity, and about a third of its net income last quarter.
So it is unsurprising that the leaders of the banking industry might like the FDIC to consider another idea. The WSJ reports:
Banks have spent the past week or so testing what would be a clever gambit: Paying billions of dollars they collectively owe to replenish a federal deposit insurance fund using Treasuries instead of cash.
The idea — floated to regulators and lawmakers by PNC Financial Services Group and supported by others — could allow banks to take securities that are currently worth, say, 90 cents on the dollar, and give them to the Federal Deposit Insurance Corp at full price . ..
An FDIC spokeswoman said the agency’s rules don’t allow banks to pay it in Treasuries
The obvious problem here is that, as the FDIC points out, it would require a rule change to make this proposal work, and by the time that gets done, who knows where the banks will be. But putting that aside, you might argue that the Treasuries have discounted market values because rates have risen, but if the FDIC holds the Treasuries to maturity, it will ultimately get paid in full.
If you argued this way, you would be wrong. A Treasury that is trading at 90 cents on the dollar is really worth 90 cents; it is not worth 90 cents unless you can hold it to maturity in which case it is worth 100 cents. The time value of money and duration risk are real things with real prices. The banks are just saying “we would like to pay less, please”.
Alternatively, you might argue that the FDIC could actually save money by taking the Treasuries at face value, because doing so would take mark-to-market losses and duration risk off the bank’s balance sheets. This would make the banks less risky, leaving the FDIC with fewer potential messes to clean up later. But this is wrong too. The FDIC could just lower the assessment, and the cash left on the banks’ balance sheets would have a similar risk-reducing effect.
The banks’ idea is just sleight of hand. The FDIC should wave it away, if they have not already.
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