October 16, 2024

QuickTakes

Cockroaches

"When you see one cockroach, there are probably more," JPMorgan CEO Jamie Dimon said on the company's earnings conference call earlier this week in relation to the First Brands and Tricolor Holdings fallout. These are two auto-related companies that have recently declared bankruptcy. First Brands, which is in the auto parts business, reportedly is facing a criminal investigation. Tricolor specialized in used car sales and subprime auto financing. Zions Bank said Wednesday evening that it faced a sizable charge due to bad loans to a couple of borrowers. Western Alliance then alleged on Thursday that a borrower had committed fraud. 

So far, that seems like a few cockroaches, not a significant infestation. Nevertheless, the KBW Regional Banking ETF fell sharply today. The regional banks account for approximately 7.8% of the Russell 2000 index, which also experienced a decline today (chart).

The Financial sectors of the S&P 500, S&P 400, and S&P 600 have been weak in recent days (chart). The larger banks that reported their Q3 earnings results on Tuesday and Wednesday mostly beat expectations, driven by better-than-expected investment banking revenues. They are included in the S&P 500.

The S&P 500's Diversified Banks and Investment Banking & Brokerage industries remain near their recent record highs (chart). If the regional banks' stock prices continue to decline due to an increase in bad loans, it could trigger a wave of acquisitions of them by the large banks.

We aren't too concerned about cockroaches in the private credit market. Loan losses in that market reduce the rates of return on diversified portfolios of such loans. They don't trigger an economy-wide credit crunch, which has often occurred when bad loans hit the banking system hard.

The bad news about the cockroaches pushed the S&P 500 back down near its 50-day moving average today. We still expect it to hold, though we can't rule out a test of the 200-day moving average if the 50-dma fails to support the index. Widespread expectations of another two Fed rate cuts before the end of this year suggest that further downside should be limited.

Meanwhile, the two Bull/Bear Ratios we monitor suggest that sentiment currently isn't overly bullish (chart).

The recent escalation of Trump's trade war with China, along with concerns about loan losses in the credit market, also weighed on the price of oil recently (chart). That should continue to lower the pump price of gasoline, which would help to moderate headline inflation rates and boost consumer spending.

The federal funds futures market is showing that the Fed is expected to lower the federal funds rate by 25bps at least twice over the next six months and four to five times over the next 12 months (chart). Fed officials are leaning toward providing the Fed Put that the financial markets expect.

The 10-year Treasury bond yield fell just below 4.00% today, which is lower than our 4.25%-4.75% range. We concede that it might test the 2024 low of 3.63%. But we expect to see the yield back in our range by early next year, if not sooner. We will reconsider our position when September's CPI is released on October 24. It might be hotter than expected.

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