Providing perspective on the regional bank turmoil - Butler Financial, LTD
Important Tax FAQs

Resources

Providing perspective on the regional bank turmoil

With regional bank volatility grabbing headlines, CIO Larry Adam looks at what this activity means for the economy and asset classes.

To read the full article, see the Thoughts on the Market publication linked below.

Over the past two weeks, the regional banking turmoil has reemerged as First Republic Bank failed and was ultimately sold to JP Morgan, shares of other smaller regional banks like PacWest and Western Alliance fell demonstrably, and the merger between TD Bank and First Horizon was surprisingly scuttled. While the S&P 500 has been largely flat over this time period, the KBW Regional Banking Index has plummeted and is now down 61% year-to-date, sitting at a three-year low. Volatility in the regional banking sector is likely to continue into the near future. While headlines of bank failures are unsettling for investors, it’s important to put the recent bout of banking sector volatility into perspective and consider what it means for the economy and asset classes.

Economy – not on the edge quite yet

A healthy banking system is important to the growth of the economy, and, fortunately, the recent turmoil has not yet reached a level that would cause us to significantly change our economic forecasts. Tighter lending standards by the Federal Reserve (Fed) were expected to cool the economy and take the edge off inflationary pressures – which it has. But the recent turmoil in regional banks, caused primarily by poor strategy and risk management, will likely have a bigger impact on business lending than on the consumer.

Impact on lending | As a result of the Fed tightening cycle – 10 consecutive meetings of increasing the Fed funds rate – and rising borrowing costs from credit cards to auto loans, lending standards had already been tightening leading into this recent banking turmoil. In fact, at the end of the first quarter, it was noted that a net 45% of banks had reported tightening lending standards, up from -15% (suggesting easing lending standards) just one year ago. On May 8, updated figures from the Fed’s Senior Loan Officer Survey for 1Q will be released and likely show the trend of further tightening in lending standards. In particular, small/medium sized banks have likely tightened their lending standards which in turn will weigh on both small business borrowing and investment going forward.

Small businesses hit | Relative to larger businesses, small businesses rely heavily on regional and smaller banks rather than larger banks (>$250 bn in assets) for financing. As a result, the regional banking turmoil will disproportionally hamper smaller businesses. It is not surprising that the net respondents in the NFIB Small Business Optimism Index reported easier availability of loans declined to the lowest level (-9%) since 2012 and only 2% saw now as a good time to expand, the lowest level since the Great Financial Crisis. As small businesses make up ~48% of total employment and generate ~44% of total economic activity, a slowdown in small businesses will be a headwind for economic growth going forward.

The consumer remains in the driver’s seat | While tightening lending standards and a potential slowdown in small business activity potentially pose headwinds for economic growth going forward, we do not want to overestimate its impact. Why? Because consumer spending makes up ~70% of GDP and is generally the main driver of the trajectory of the economy. Until a significant slowdown in the labor market occurs, which has not yet occurred (evidenced by the U.S. economy adding 253k jobs in April), healthy consumer spending will likely buoy any weakness in business investment.

Fixed income downward pressure on yields

The ongoing tremors in the banking sector have led to sharp swings in Treasury yields, with the 2-year Treasury moving more than 20 basis points (bps) in a day, mostly to the downside, on nine separate occasions over the last 60 days. Moves of this magnitude are exceptionally rare. The last time the market was so volatile was in the 1980s.

Market turmoil, whatever shape it takes, has always been met with a policy response. And while the Fed and regulators have stepped in to shore up confidence and provide liquidity to banks during this recent turmoil, the markets remain concerned there may be more shoes to drop. With uncertainty increasing, there is a disconnect between the market’s view and Fed rhetoric regarding the future path of interest rates.

This tug-of-war between the markets and the Fed seems likely to persist. As we expect a mild recession to unfold in the second half of this year, we maintain our call for a 3.0% Treasury yield at year end and an up-in-quality bias, favoring investment grade and municipals over high-yield debt. A challenging economic backdrop and tighter lending standards could lead to a potential increase in lower-quality bond defaults that have not yet been priced into high-yield spreads.

Equities the stock market is not the economy

We have said before that it is important to recognize that the economy and stock market can differ. As a result, while it is important to understand the dynamics driving the economy and financial conditions, it is more important to assess how they specifically impact the stock market.

Influence on the S&P 500 is minimal | The banking turmoil has driven a significant number of headlines, but how much does the ongoing turmoil in regional banks impact the stock market? The direct impact of the regional banking turmoil should be minimal on the S&P 500 Index as the regional banking sub-industry is only ~0.30% of the Index as of May 3, 2023. As regional banks have declined in price they’ve become a smaller portion of the large-cap broad market indices and will contribute little to those returns going forward. Consolidation in the banking sector is now a tailwind for large-cap equity returns as larger banks are much more insulated to the near-term risks these regional banks face.

Bottom line

We do not have a crystal ball as to how long the regional banking turmoil will last, and the volatility and headlines from it will likely continue to be uncomfortable. However, as we outlined above, while there will be modest economic spillover effects, the woes of the banking sector will likely remain contained within the regional banking space. As a result, we do not believe that this turmoil will push the U.S. into a severe recession (we expect a mild recession beginning in the third quarter of 2023 as a result of a weakening labor market) and reiterate our 4,400 year-end target for the S&P 500.

Read the full
Thoughts on the Market



All expressions of opinion reflect the judgment of the author(s) and the Investment Strategy Group, but not necessarily those of Raymond James & Associates, and are subject to change. This information should not be construed as a recom­mendation. The foregoing content is subject to change at any time without notice. Content provided herein is for infor­mational purposes only. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Economic and market conditions are subject to change. Investing involves risks including the possible loss of capital. Material is provided for informational purposes only and does not constitute a recommendation. Diversification and asset allocation do not ensure a profit or protect against a loss.

The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Diversification and asset allocation do not ensure a profit or protect against a loss.

INTERNATIONAL INVESTING | International investing involves additional risks such as currency fluctuations, differing finan­cial accounting standards, and possible political and economic instability. These risks are greater in emerging markets.

OIL | Investing in oil involves special risks, including the potential adverse effects of state and federal regulation and may not be suitable for all investors.

The Consumer Price Index (CPI) | is a measure of inflation compiled by the US bureau of Labor Studies.

Personal Consumption Expenditure Price Index | The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services.

DESIGNATIONS

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP® and CERTIFIED FINANCIAL PLANNER™ in the U.S.

Investments & Wealth InstituteTM (The Institute) is the owner of the certification marks “CIMA” and “Certified Investment Management Analyst.” Use of CIMA and/or Certified Investment Management Analyst signifies that the user has successfully completed The Institute’s initial and ongoing credentialing requirements for investment management professionals.

CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.

FIXED INCOME DEFINITION

AGGREGATE BOND | Bloomberg US Agg Bond Total Return Index: The index is a measure of the investment grade, fixed-rate, taxable bond market of roughly 6,000 SEC-registered securities with intermediate maturities averaging approximately 10 years. The index includes bonds from the Treasury, Government-Related, Corporate, MBS, ABS, and CMBS sectors.

HIGH YIELD | Bloomberg US Corporate High Yield Total Return Index: The index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below.

S&P 500 | The S&P Total Return Index: The index is widely regarded as the best single gauge of large-cap U.S. equities. There is over USD 7.8 trillion benchmarked to the index, with index assets comprising approximately USD 2.2 trillion of this total. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.

KBW REGIONAL BANKING INDEX | The KBW Regional Banking Index is a benchmark stock index for the regional banking sector representing small to medium U.S. national regional banks.

RUSSELL 2000 INDEX | The Russell 2000 Index is a small-cap U.S. stock market index that makes up the smallest 2,000 stocks in the Russell 3000 Index.

NFIB SMALL BUSINESS OPTIMISIM INDEX | A composite of ten seasonally adjusted components, providing an indication of the health of small businesses in the US.

INTERNATIONAL DISCLOSURES FOR CLIENTS IN THE UNITED KINGDOM | For clients of Raymond James Financial Interna­tional Limited (RJFI): This document and any investment to which this document relates is intended for the sole use of the persons to whom it is addressed, being persons who are Eligible Counter parties or Professional Clients as described in the FCA rules or persons described in Articles 19(5) (Investment professionals) or 49(2) (high net worth companies, unincorpo­rated associations, etc.) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (as amended)or any other person to whom this promotion may lawfully be directed. It is not intended to be distributed or passed on, di­rectly or indirectly, to any other class of persons and may not be relied upon by such persons and is, therefore, not intended for private individuals or those who would be classified as Retail Clients.

FOR CLIENTS OF RAYMOND JAMES INVESTMENT SERVICES, LTD.: This document is for the use of professional investment advisers and managers and is not intended for use by clients.

FOR CLIENTS IN FRANCE | This document and any investment to which this document relates is intended for the sole use of the persons to whom it is addressed, being persons who are Eligible Counterparties or Professional Clients as described in “Code Monetaire et Financier” and Reglement General de l’Autorite des marches Financiers. It is not intended to be dis­tributed or passed on, directly or indirectly, to any other class of persons and may not berelied upon by such persons and is, therefore, not intended for private individuals or those who would be classified as Retail Clients.

FOR CLIENTS OF RAYMOND JAMES EURO EQUITIES | Raymond James Euro Equities is authorised and regulated by the Autorite de Controle Prudentiel et de Resolution and the Autorite des Marches Financiers.

FOR INSTITUTIONAL CLIENTS IN THE EUROPEAN ECONOMIC AREA (EE) OUTSIDE OF THE UNITED KINGDOM | This document (and any attachments or exhibits hereto) is intended only for EEA institutional clients or others to whom it may lawfully be submitted.

FOR CANADIAN CLIENTS | This document is not prepared subject to Canadian disclosure requirements, unless a Canadian has contributed to the content of the document. In the case where there is Canadian contribution, the document meets all applicable IIROC disclosure requirements.

Source: FactSet, as of 5/4/2023

INTERNATIONAL HEADQUARTERS: THE RAYMOND JAMES FINANCIAL CENTER 880 CARILLON PARKWAY // ST. PETERSBURG, FL 33716 // 800.248.8863 RAYMONDJAMES.COM

© 2023 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. © 2023 Raymond James Financial Services, Inc., member FINRA/SIPC. Investment products are: not deposits, not FDIC/NCUA insured, not insured by any government agency, not bank guaranteed, subject to risk and may lose value.

Other posts you might like
ButlerFinancial
Navigating Medicare decisions in tricky situations

Retirement & Longevity What encore careers, young dependents and early retirement mean for your...

read more
ButlerFinancial
7 money moves to help enhance your cash

Retirement & Longevity Sometimes savings can be easier to find if you know where to look. Beyond the...

read more
ButlerFinancial
Don’t let a natural disaster derail your business

Business Ownership Protect what you built with the right policy and a contingency plan. From tornados and...

read more