Will The Banking Crisis Cancel Hopes Of A Bull Run This Year?
The S&P 500 and Nasdaq Composite were both down sharply last week, declining 4.5% and 4.7%, respectively and closing on their lows. The significant declines in the indexes combined with one of the worst weekly drops (16%) since March 2020 for the SPDR S&P Regional Banking ETF (KRE) was related to the failure of Silicon Valley Bank (SIVB) last week, which marked the second-largest failure of a financial institution in United States history.
The failure was related to not having enough cash on hand nor liquid assets to convert immediately to cash, and with Silvergate Bank’s (SI) downfall earlier in the week which already created some anxiety among investors, it’s possible this could have been one reason for a sudden increase in depositor demands and the ensuing bank run.
Although this is certainly devastating news, we’ve seen regulators act quickly, with the New York State Department of Financial Services taking possession of Signature Bank New York to ensure deposits are protected in what’s being called a “similar systemic risk exception” to Silicon Valley Bank where Treasury Secretary Janet Yellen ensured all deposits at Silicon Valley Bank were fully protected.
While this has stabilized financial markets and keep short sellers at bay that might have otherwise been looking for other vulnerable targets in the Financial Sector (XLF), this decision could severely erode confidence in the Federal Reserve’s “raise at all costs” narrative that’s seen it already increase rates to 4.5% – 4.75% at breakneck speed.
Some investors might view this as positive news, and it certainly is a positive over the short-run as there’s nothing like fears of a bank run to push the market into a downward spiral. However, if the Federal Reserve is forced to take its foot off the proverbial gas regarding rate hikes, it could come up short when it comes to stamping out inflation, and it may have to revisit rate hikes again down the road if it’s clear that enough has been done.
The other worry is that the Fed Put is now back in place which could result in an increase in risk-taking among market participants if they think the Federal Reserve has their back. This is not ideal, and we were finally seeing substantial progress in reeling in speculative activity with the Federal Reserve’s credibility it’s gained over the past 12 months by not wavering despite the negative market reaction.
Overall, I see this news as short-term bullish for the market but medium-term and long-term neutral, given that the previous course taken by the Federal Reserve was ripping the bandaid off at all once, and potential rate cuts following a pause once inflation cooled down. The updated course could be a 25 basis point hike this month followed by a pause to bandage up the current situation, but it then leaves risk on the table that inflation remains above the Fed’s target and stays in the 5% range, leading the Federal Reserve to come back later to finish what it started.
In summary, last week’s news was certainly a pivotal development for the market and one that could lead to choppier markets for longer, but with a bullish short-term and medium-term bias (1-6 months).
Moving to the technical picture, while last week’s decline was rough, it did nothing to impact the short-term picture, which improved last month when we saw a golden cross on the S&P 500 (50-day up through the 200-day moving average). However, this recent strength has not yet translated to an improvement in the bigger picture, with both indexes remaining below their 20-month moving averages (requires a monthly close above 4200). Meanwhile, though the decline was rough, it actually set up another bullish signal, which was a 90% downside volume day (last Thursday March 9th) shortly following a new breadth thrust (Jan 12th, 2023).
Historical forward returns and drawdowns (D/D) are shown below, with an average forward 3-month return of 8.26% and an average 6-month forward return of 10.66%, as well as an average drawdown of just 2.72% and 2.76%, respectively.
(Source: Author’s Data & Table)
Assuming this plays out like prior signals (the most recent signal was October 26th, 2020, we would see the S&P 500 trade up to 4270 by mid September, which is in line with the breadth thrust signal that suggests we should see 4400 by mid summer and potentially 4600 on the S&P 500 by year-end. Meanwhile, the average drawdown in this data set suggests that we should see a floor for the market near 3750, which is consistent with the breadth thrust data shared in previous updates that suggests a range for the market this year of 3700-4600 in line with past breadth thrusts. Obviously, these signals could fail, but with 88% win rates historically and limited drawdowns, I see this as the time to be optimistic, not pessimistic like everyone appears to have become as of last week.
(Source: CBOE Data, Author’s Chart)
So, what’s the best course of action?
Heading into the week, the S&P 500 is back in the lower portion of its strong support/resistance range (3500 vs. 4315) at 3860 and also in the lower portion of its range using short-term support at 3765 – 4315 resistance, resulting in a slightly positive reward/risk setup for the market short term. Given that the 90% downside volume day which often occurs post-breadth thrust is out of the way and we see strong medium-term returns with limited drawdowns following these signals in a post-breadth thrust environment, I would strongly consider adding to my position in the S&P 500 if we saw a pullback below 3780, especially with the recent increase in negative sentiment.
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