Banking crisis: Phase 2 and 3, rising corporate profits and falling economic growth - can this go well?
Chart of the week
The chart on the left shows the earnings estimates for the largest stocks in the US for the next four quarters. This has been falling for three quarters but is expected to rise again from now on.
The chart on the right shows the estimates of market participants for the growth of the gross national product in the USA. Market participants expect quite high growth here for the next two quarters and then growth is expected to fall sharply.
Why this is important
The two expectations of market participants are diametrically opposed. If the overall economy weakens, then profits cannot rise.
Conclusion: earnings expectations for the next three quarters are too high. We expect earnings expectations to be adjusted downward in the coming weeks. This will also severely limit the momentum on the stock markets.
The chart above shows the estimates on the total earnings of all stocks in the US. The so-called top-down estimate, derived from futures contracts on the S&P 500. The chart below sums up the expectations of each company in the index. The so-called bottom-up estimate.
Here, things already look a bit more reasonable. Earnings expectations for the first quarter of 2023 are expected to fall by 7%, and by 6% in the second quarter. From then on, it is expected to rise again. These expectations are also too optimistic.
Many investors expect a recession. But in a recession, earnings don't just fall by 7%.
The chart shows global corporate earnings changes (EPS, earnings per share, dark blue) and a Bank of America model based on various macro indicators. The model predicts a 16% reduction in profits. That would be well within realistic bounds, even historically since 1940. That is then also the profit decline we expect.
Banking crisis: Phases 2 and 3
In our view, the banking crisis has three phases. At present, the three phases are not taking place in succession, but in parallel.
Phase one of the banking crisis:
The chart shows the outflow of customer funds from banks in recent weeks in a historical comparison since 1970. The outflow exceeds anything seen before. The question now is, of course, where is the money flowing?
The chart shows the difference between the interest rate on US government bonds and the risk of equity investments. The current interest rate in the USA is between 3.5% and 5%. This is an attractive interest rate. The money that flows out of the banks then also goes directly into government bonds.
Phase two of the banking crisis:
As a reminder, we have seen the fastest rate hike cycle since 1940. After the banks, investors are now looking for the next weak spots after the banks. And that is real estate companies that are misfunded or poorly funded. Real estate companies often provide daily or weekly liquidity, but invest the money for years over the long term.
The graph shows house prices in different countries. With the high interest rates, houses can no longer be sold because the buyer can no longer finance them with the high interest rates.
Especially real estate companies that invest mainly in commercial properties are now the next victims. Investors are withdrawing money on a massive scale and prices are falling sharply.
Phase two of the banking crisis:
The chart shows the change over two weeks in bank lending. As banks are confronted with money outflows, they are also able to lend less. Even the rescue measures taken by the US authorities do not change this. Banks are reducing risks and no longer lending money. The decline in lending in the U.S. is the lowest lending since the number has been measured since 1975.
That in turn, may exacerbate the recession now expected.
Interest rates, investor risk appetite and inflation
In view of investors' concerns, many are reducing their risk. The chart shows the ratio of investors in bonds (low risk) and equities (high risk). Investors are currently investing so lopsidedly in bonds that it only takes a little positive news to cause the stock markets to rise. This is currently the ray of hope on the horizon.
The chart shows which interest rate hike and with what probability investors expect at the next meeting of the U.S. Federal Reserve. An increase of 0.25% is expected. During the banking crisis, many investors expected that the Fed would not raise interest rates now. The probability for unchanged interest rates was 51% a week ago; now it is only 28%.
On Friday of last week, the number of new job creation was published in the US. This was a lot lower than expected.
The chart shows the creation of all new jobs (except in the food sector, light blue) and the plans of small and medium-sized firms in the U.S. which jobs they intend to advertise (NFIB, dark blue). The small firms' plans have good predictive power for the general labor market. It can therefore be assumed that wage inflation will also cool and the unemployment rate will rise. This news is currently being received positively by the stock market, as the central bank will then not have to raise interest rates further.
A big driver of inflation last year was the sharp rise in food prices. One of the main reasons for the increase was the massively higher cost of fertilizer for food producers. Here, too, the all-clear can be given. Fertilizer prices have fallen sharply in recent months and should also lead to a reduction in inflation in the food sector.
Looking at this data, the interest rate hike by the U.S. Federal Reserve in May is likely to be the last for some time.
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