Banking crisis causes volatile week for markets, stocks end mixed

In the financial markets, hindsight is forever 20/20, but foresight is legally blind. And thus, for most investors, market timing is a practical and emotional impossibility. – Benjamin Graham 

After two bank failures the previous week, the U.S. banking system was in the spotlight again last week and was largely responsible for wild swings in the major stock averages. But when the dust finally settled on Friday, the S&P 500 Index gained 1.4% while the Dow Jones Industrial Average edged slightly lower. Surprisingly, the Nasdaq Composite Index surged 4.4% and almost completely erased its loss from the prior week as it benefited from falling bond yields which boosted technology and other growth stocks. The week began with a joint statement from the Federal Reserve, Treasury Department and FDIC that said that all Silicon Valley Bank and Signature Bank depositors would be made whole and have access to their money. That news coupled with the release of the February consumer price index (CPI), which met expectations and increased at the lowest rate since September 2021, resulted in a stock market rally that saw the Dow break its 5-day losing streak. However, stocks plunged the following day when Saudi National Bank, the largest investor in Credit Suisse, said it could not provide any more funding to the bank. Credit Suisse had already been embroiled in several regulatory scandals and this news caused its stock and the stock of regional banks to plummet. After it was learned that First Republic Bank was also in trouble, a group of the largest banks in the country deposited $30 billion in the bank to shore up its balance sheet and alleviate any panic. Swiss National Bank also came to the rescue of Credit Suisse by loaning it up to $54 billion to assure its short-term liquidity needs. Stocks soared on Thursday as financial regulators both in the U.S. and Europe had taken the necessary steps to provide backstops and restore confidence in the banking system. Shortly thereafter, UBS, a Swiss multinational investment bank and financial services company, announced that it would buy Credit Suisse for $32 billion. There is a popular adage in the market that once the Federal Reserve begins raising interest rates, it will continue to do so until something breaks. The stress in the banking system may be the result of that and there was speculation that the Fed may leave interest rates unchanged when it meets next week. But the odds still favor a quarter of a percentage point increase in the fed funds rate to help bring down inflation.

Last Week

The core producer price index (PPI) for February, which excludes food and energy prices, was flat and less than expected while it increased 4.4% on an annual basis, the same as in January. Retail sales in February dropped and were in line with estimates while housing starts in February soared and were nearly 10% higher than in January and well above estimates. Weekly jobless claims totaled 192,000, a decrease of 20,000 and below estimates of 205,000. The University of Michigan consumer sentiment index fell in March for the first time in four months.

The European Central Bank (ECB) raised its benchmark interest rate by 50 basis points (a basis point is one hundredth of one percent).

For the week, the Dow Jones Industrial Average edged slightly lower by 0.2% to close at 31,861 while the S&P 500 Index rose 1.4% to close at 3,916. The Nasdaq Composite Index surged 4.4% to close at 11,630.

This Week

Existing home sales for February are expected to be higher than in January as sales have now fallen for 12 straight months as rising mortgage rates have taken a toll. New home sales for February are forecast to be less than in January. February durable goods orders are expected to increase slightly after dropping last month.

The Federal Open Market Committee (FOMC) meets and announces its monetary policy decision, which is expected to be an increase in the federal funds interest rate of 25 basis points to a range between 4.75% and 5.0%. Prior to the collapse of two banks and the turmoil at two others, the question was whether the Fed would hike rates by 25 or 50 basis points.

Among the most notable companies scheduled to report quarterly earnings this week are Nike, Foot Locker, GameStop, Accenture, General Mills, Winnebago Industries, KB Home and Darden Restaurants.

Portfolio Strategy

The most important event this week for the markets will be the Federal Open Market Committee (FOMC) meeting that takes place on Tuesday and Wednesday. The recent bank failures and the loss of confidence in small and medium-sized banks caused a flight to safety to Treasury securities last week that culminated in a steep drop in yields. (Bond prices and yields move in opposite directions). After starting the week at 4.6%, the yield on the 2-year Treasury Note, which is the maturity most sensitive to expectations of future Fed policy, dropped to 3.85%. The plunge in the yield was the biggest since the aftermath of the stock market crash on October 19^th, 1987, also known as Black Monday. The yield on the 10-year Treasury also fell to 3.45%. The collapse of Silicon Valley Bank and Signature Bank may be deflationary in that it could help the Federal Reserve by tightening credit and slowing the economy.  For this reason, there is a school of thought that believes the Fed should pause and leave the federal funds rate unchanged due to the banking crisis. But others believe that the Fed will raise interest rates by 25 basis points to continue its inflation fight, which is still running well-above its 2% target. The Fed must also consider falling oil prices as West Texas Intermediate crude oil plunged 13% last week to reach a 52-week low. For this reason, it is highly unlikely that the Fed would raise the benchmark rate by 50 basis points. Given the stress created by the two bank failures and its potential effect on the economy, the futures market is betting that this could be the last rate hike by the Fed with rate cuts possible later in the year to avert a recession.