Mid-Month Update: 2023 Outlook Update – Remain Calm
By: Jeffrey A. Hirsch & Christopher Mistal
March 16, 2023
This is the Q1 chop we forecasted. However, with the Dow’s December Low (2023 STA p 36) being breached, banking sector woes, government, and Wall Street fearmongering, as well as heightened geopolitical tensions with Russia and China we are adjusting our 2023 forecast and outlook back to our original base case scenario, which is still bullish: “Slightly below average pre-election year gains of 10-15%.”
As we see the plunge protection teams stepping up here in the U.S. and overseas and the public commitments from the powers that be to backstop these poorly managed and capitalized regional and niche banks, we believe the fallout will be contained, the contagion prevented, and a banking crisis averted. 
Looking back through the annals of bank crises since the Panic of 1907, the current banking woes pale in comparison in relative economic impact as a percent of GDP. Even the most recent comparison of SVB’s $209 billion in assets failure and second only to Washington Mutual’s $307 billion asset failure in September 2008 is misleading. 
Back in 2008 WaMu’s assets were about 2% of the $15 trillion U.S. economy vs. SVB’s at less than 1% of the current $26 trillion economy. And the situation back in 2008 during the GFC was systemic and widespread up to the top of the “too big to fail” banks. Whereas now we are looking at a few select regional, niche VC and crypto related banks with concentrated deposits and a lack of financial risk management.
There are broad differences as well. There was no Federal Reserve back in 1907. And since the Fed’s founding in 1913 interest rates were not managed – or micromanaged – anything like they have been since the GFC. If you look back through the Fed statements and minutes in the old days, as we have, the ranges were wide, and they were reacting to the bond market. Also remember the FDIC (Federal Deposit Insurance Corporation) was created in June 1933 after the run on the banks when FDR declared a 9-day banking moratorium on March 5, 1933. 
This excerpt from the end of the Minutes of the FOMC Meeting on August 18, 1981, the meeting just before the recently noted previous historic yield curve inversion in September 1981 might shed some light. (https://www.federalreserve.gov/monetarypolicy/fomchistorical1981.htm
The Chairman may call for Committee consultation if it appears to the Manager for Domestic Operations that pursuit of the monetary objectives and related reserve paths during the period before the next meeting is likely to be associated with a federal funds rate persistently outside a range of 15 to 21 percent.
There is just no comparison between today’s Fed and the Fed of the 1970s and 1980s. Forty years ago, interest rates were set by the bond market and the Fed would meet every so often to adjust their rates to match the bond market. This is the exact opposite of what is happening today. Putting things further into perspective, from the FDIC’s 2022 Q4 report there are 4,746 reporting institutions, 4,157 commercial banks and 589 savings institutions – and so far, three have failed. 
Let’s look at the technical picture. Near term support levels have been crossed, but the bottom has not fallen out and the market is trying to find support near the recent lows around the downtrend line from the 2022 highs. S&P broke the 3980-support level we highlighted in the March Outlook and on the March 1 Members Webinar. The next support test is around S&P 3780-3800 near its December lows.
[S&P Chart]
After being a bastion of safety in 2022 and holding up best, DJIA has underperformed in 2023, down –2.7% year-to-date at today’s close. Whereas S&P is up 3.1%. As previously mentioned DJIA closed below its December Closing Low on February 28 and then fell through support at 32500. DJIA is also looking for support near the 2022 downtrend line. The next test is in the 31000-31500 range. 
[DJIA Chart]
NASDAQ has been a source of resilience and strength this year after being the market’s biggest loser last year, down 33% in 2022. NASDAQ broke support we were eyeing at 11200 but has held rather firm with the next test of support near 11000. In contrast to DJIA and S&P, the NAS is still up 12% YTD – and NASDAQ 100 (NDX) or the QQQ are still up 15% YTD and just a tad off their 2023 highs. So technically there’s some work to do here, but NASDAQ and big tech action is encouraging.
[NASDAQ Chart]
Bearish sentiment ticked up the past several days with VIX popping up to 30 on Monday. CBOE Equity Only Put/Call Ratio hit 1.11 on Friday. There is some fear out there and if it recedes that can signal the end of this bout of selling. VIX also tends to make a seasonal high in March.
This week’s Investor’s Intelligence US Advisors Sentiment showed 40.3% Bulls, 27.8% Bears and 31.9% Corrections. There is a bit of lag here as it is a weekly reading, but we would suspect after this week’s market action there will be more bears and less bulls in next Tuesday’s reading. The extreme lows in the Bulls/Bears difference last June and October correlate quite well with bear market and other significant lows over the past 20 years.
[II US Advisors Sentiment Charts]
A week ago on Thursday March 9, all eyes were focused on the upcoming February Employment report, CPI and PPI readings, but regional bank woes largely pushed these key reports to the background. As we anticipated, February’s jobs numbers were better than anticipated while CPI was inline, and PPI was softer than expected. However, this positive data was largely ignored.
Focusing in on the 12-month trailing percent change of two of our favorite inflation metrics, CPI – All Items (red line) and PPI – All Commodities (blue line) shows inflation is slowing and heading back toward historical averages. In the case of PPI, it has rapidly declined from its peak above 20% and appears to be heading toward negative territory. It is also important to note the historical relationship between producer prices and consumer prices. Since 1950, producer prices have experienced much greater swings than consumer prices. More importantly, PPI has lead CPI in nearly all major trends.
Based upon the current trajectory of PPI, its 12-month percent change could be negative as soon as next month’s update scheduled to be released on April 13. If PPI is flat or little changed in June, its 12-month change could approach negative 8%. Historically, when PPI was that deeply negative, CPI also retreated briskly. Given the Fed’s known fears of deflation, a pause in rate hikes could happen soon.
[2-Yr Treasury yield versus Fed Funds Effective Rate FRED Chart]
The current shock to the regional bank sector caused a sharp reversal in the once steady rise of the 2-Year Treasury yield. Last week the 2-year Treasury was above 5%, yesterday it was below 4%. Historically, the 2-yr Treasury yield (blue line) has led the Fed Funds Effective Rate (red line). This chart also suggests that the Fed could be close to the end of the current tightening cycle.
Now that the steep 450-basis-point rate increase in less than a year is starting to bite, the Fed will likely begin to backoff. Based upon CME Group’s FedWatch Tool, as of today, there is a 79.7% chance of a 0.25% increase in interest rates at next week’s FOMC meeting. After this month’s meeting the tool’s indications become less clear, but it does appear the market is currently expecting rates to decline by the end of this year.
Inflation is easing, the jobs market is holding up and interest rates could be lower before yearend. Provided regional bank jitters do not spin out of control, it appears the Fed can pull off a soft economic landing which in turn is likely to lift stocks.
Finally, let’s not forget this is a pre-Election year and the overall bullish history that represents. Stocks have corrected here in February and March, but this was after an overheated run where prices had gotten a bit ahead of pre-election year trends, the economy, and the Fed. Perhaps we’ll just move more in line with the red STA Aggregate Cycle trendline. 
As we mentioned in the members webinar, headwinds may push the usual 4-Year Cycle Sweet Spot outsized gains a little further out this year and perhaps into 2024. However, as shown in the familiar seasonal pattern chart below S&P 500 appears to be finding that early pre-election year low point and is poised for the Q2 uptrend in the chart. 
[S&P Seasonal Chart]
Triple Witching Weeks have tended to be down in flat periods and dramatically so during bear markets. If this Triple Witching week ends higher or is not down big, it could be an indication we have seen the worst of the banking fallout and the end of the pullback. Positive March Triple Witching weeks in 2003 and 2009 confirmed the market was back in rally mode.
In the old days March used to come in like a bull and out like a bear, but nowadays crosscurrents at the end of the first quarter have turned March into an inflection point in the market where short-term trends often change course. The market is clearly at an important juncture and it’s a good time to remember Warren Buffet’s wise words to “Be greedy when others are fearful.”
Considering recent developments, we are going back to our Base Case scenario from our Annual Forecast for the balance of 2023. Bank failures are never a good thing, but the swift actions of regulators likely prevented further damage to the industry. At the least, the banks are likely to be under even greater scrutiny going forward. In the near-term we expect more volatile trading. Further out we expect the market, and the economy will recover like they both have historically done. In the meantime, keep a closer eye on portfolio holdings and heed all stop losses.