Shares Recover Some Ground Ahead of Fed, Lloyds Profits Double

European Markets Tumble Amid Bank Fears

Stock markets in Europe fell sharply yesterday, partly on catching up with the US from Monday, driven by angst over the banks. Regionals in the firing line again soured the mood, that had been lifted by the JPM takeover of FRC. PacWest Bancorp slid almost 28%, -71% for the year, whilst Western Alliance fell 15%, -47% YTD. KBW was down more than 4%, and JPM also declined a modest 1.6%. European indices fell 1-1.5% for the day, whilst Wall Street followed with roughly 1% declines on the session and volatility spiked with Vix futures (VIXX) hitting 20. This morning, Europe is trading a bit firmer ahead of the Fed rate decision later on, with apparently some giveback from the selling yesterday. The FTSE 100 rallied 0.5% to recapture 7,800, whilst the DAX nudged 15,800 with a similar rally in early trading. US futures are a tad firmer; Ford, Starbucks and AMD all beating last night on earnings but all suffering in the after-hours market…beats getting trashed signals risk is not on. Between the Fed hiking rates, the banking crisis and worries about the debt ceiling in the US, it’s not a great time for risk assets.

Fed Decision Day

25bps seems assured, but worried about the economic outlook...could be looking to signal a possible pause but the thing is as soon as it does anything to suggest ‘pivot’ the market rallies and financial conditions loosen. US 10yr yields trade lower around 3.4% this morning, with the 2yr under 4%. Markets price in an 89% chance the FOMC follows through with its third consecutive quarter-point rate hike – down from 95% yesterday – implying investors are just seeing a slightly more dovish Fed in light of the First Republic sitch. Another quarter point move would bring the Fed funds rate to a range of 5%-5.25%, in line with its current central forecast for the peak in interest rates – so the commentary in the statement and Powell’s remarks will be crucial to market pricing for future hikes – currently the market doesn’t see it; I think the market is wrong. The recent banking crisis may see the Fed look to be more cautious, whilst there has been evidence of disinflation, albeit core readings for price growth remain stubbornly high. Hard to see the Fed be too hawkish until that is resolved, but at the same time it has to keep tight with its inflation message.

Decisions Data and US Debt

Data yesterday pointed to slowing in the US labour market as the JOLTS jobs report hit a 2-year low, down to 9.59mn vacancies from upward revised 9.97mn in Feb, lowest since April 2021. ADP employment report today seen at +148k, whilst ISM services PMI seen in expansion at 51.8.

US debt default...unthinkable? 1yr credit default swaps for US government debt are soaring. The angst probably showed up most in crude oil – sinking 5% for its biggest daily decline since January amid debt ceiling fears and demand worries. CBs still raising rates...economic data softer, manufacturing in contraction. WTI (Spot) slipped further this morning to $71.32, the weakest since the end of March, whilst Brent tested $75, also the lowest it has been since March 17^th.

Looking ahead to tomorrow’s European Central Bank decision and we saw clear evidence from the bank lending surveys that credit conditions are tightening. Meanwhile EZ inflation was mixed - core cooled slightly to 5.6% but headline rose for first time in six months to 7%.

FX – second day of losses for the dollar, sharply lower versus the yen in particular after the powerful momentum trade since the BoJ last week.

Companies

Banks look in good strip in both Europe and the UK. Lloyds profits surge 50% to £1.6bn from £1.1bn on – you guessed it – higher net interest income, which jumped 20% with margins up to 3.22%. Overall costs rose 5% and net income rose 15%. Asset quality still good, retains 2023 guidance – shares flat at the open. BNP Paribas also reported a doubling in profits and UniCredit raised its guidance for the year.

Carmakers – Stellantis reports a 14% rise in revenues, Porsche profits and revenues about 25%; Aston says stronger pound helped it narrow losses. Revenues at Aston improved 27% with prices up 18% - turning a corner at last? Last night Ford shares slipped in the after-hours market as it reported stronger profit on truck demand, but its EV outlook weighed.

Know nothing and be happy? AI – everyone is focused on ‘winners’ like Microsoft or Nvidia; what about the losers? Pearson fell 15% yesterday as its US rival Chegg warned AI is hurting its business. PSON rallied 3% at the open – says it is fundamentally different to Chegg...whilst AI can give you the answers it’s not a substitute for learning, i.e. its textbooks etc. JPM notes that Chegg is like ChatGPT – it provides the answers, whereas Pearson delivers the content and the questions.

Inflated Bubbles and Excessive Leverage

Icahn Enterprises (IEP) down 20% on a Hindenburg Research report. The short-seller says IEP shares are “inflated by 75%+ due to 3 key reasons: (1) IEP trades at a 218% premium to its last reported net asset value (NAV), vastly higher than all comparables (2) we’ve uncovered clear evidence of inflated valuation marks for IEP’s less liquid and private assets (3) the company has suffered additional performance losses year to date following its last disclosure”.

Hindenburg notes that comparable businesses, such as Dan Loeb’s Third Point and Bill Ackman’s Pershing Square, trade at discounts of 14% and 35% to NAV, respectively. Retail investors are attracted by a 15% dividend yield - institutional investors are nowhere to be found in IEP.

You can and should the read the full note, which ends with this: “Overall, we think Icahn, a legend of Wall Street, has made a classic mistake of taking on too much leverage in the face of sustained losses: a combination that rarely ends well.” Too. Much. Leverage. For which you can read the whole financial sector.