Weekly Review & Outlook: September 11, 2023

Equity and bond markets both slumped last week as macro data on a whole was slightly better than expected. The “bad news is good news” script from the prior week was flipped for the near term. Expectations for a Fed pause a week from Wednesday remain the strong consensus. However, monetary policy path following the next FOMC meeting is uncertain with data such as the CME FedWatch Tool almost 50/50 in projecting another ¼ increase this year. Even more ambiguous is timing for the arrival of the long awaited recession.

Despite 3Q23 economic activity showing signs of accelerated growth from the 2nd quarter, many historic indicators such as The Yield Curve as a Leading Indicator (nearby chart) signal the greatest risk of impending recession in several decades. Market sentiment is slowly shifting from prioritizing risks from the Fed’s inflation battle to potential economic weakness in the Fed’s aftermath.

Market sentiment and consensus are funny things. In my observations sentiment changes generally start with a few contrarians defining an alternate scenario. This alternate scenario either stalls out as incorrect in the intermediate time frame or gathers momentum over time until the once contrarian view becomes the overwhelming consensus. This cycle to the market baseline sentiment is always unfolding.

In the current context, the Fed rate hike cycle began with anticipation of a “sweet & gentle” increase in rates. As inflation topped 8% a more cautious sentiment took hold. The realization of liquidity and duration risks in the banking sector plunged sentiment even lower.

One way to measure sentiment in the Banks is to look at the trailing 12-month average weekly price change for the 80+ mid-cap banks. The nearby chart graphs the past 6+ years of price change for the group. I find 8 intermediate range cycles lasting in duration from 9 weeks to nearly 2 years.

If the current bank sentiment has you worn out, that is what averaging -0.4% decline each week for a year will do. Add to that 4.21% weekly volatility and you see not only has the sector steadily fallen but we have come to expect larger price changes.

After just attending a large small and mid-cap bank conference, I saw first hand the evidence of this negative sentiment in many bank executives but especially investors. There’s no rule on how long sentiment can remain negative, but like many things in this current cycle, we’re closer to a turn than we were at any point in the year prior.