Charts of the Week

There are lots of interesting charts to share from the week that’s ending.

The ratio between home builders and regional banks is the most extreme we’ve seen possibly ever, but at the very least within the last 20+ years. With regional banks as sizable lenders for mortgages, this trend may be somewhat unsustainable. The biggest driver for homebuilders having such strong performance is a low housing stock of new and existing homes vs historical trends.

Government debt is on the rise as spending re-accelerates with more spending bills and a higher cost of debt. What’s most curious is this latest batch of spending is attempting to front-run an economic slowdown, which leaves less ammunition to fight any economic slowdown to come. Non-defense government spending has helped to prop up GDP the last two quarters, but it’s not a sustainable or desirable trend. We still believe we’re likely to see a weaker economy in the back half of this year.

Meanwhile, the US Treasury is likely to run out of resources by late July after a last minute boost in tax receipts added more funds. The debt ceiling kabuki theater is more of a charade than material disagreement.

That is to say, both parties have to come to a resolution otherwise neither will have anything resembling a win. That being said, the chances of a partial or full government shutdown to avoid a technical default are on the rise along with US 5-year credit default swaps.

In Japan, the goal has been to rekindle inflation for decades. This time the BoJ may be succeeding, but not because of their efforts as much as global supply chain shocks, rising energy and other commodity costs, a weakening yen, and because the country largely relies on imports of energy, agriculture, raw materials, and otherwise.

Speaking of the Bank of Japan, they have been adding liquidity as the Fed, ECB, and BoE are pulling liquidity out. This has helped to add some demand for global financial assets, much to the chagrin of other central banks that are attempting to tighten financial conditions in their battle against inflation.

In the US banking system, the FDIC shows about $650 billion of unrealized losses on investment securities. These unrealized losses are putting pressure on banks, which have borrowed hundreds of billions of dollars from the Fed’s Discount Window and Bank Term Funding Program, the latter of which many have confused for QE despite it being a materially different liquidity facility with rather punitive rates (4.5%-4.75%).

Only about 6% of bank investment securities are hedged, and most of that hedging has occurred at larger, less vulnerable financial institutions. Meanwhile, banks with riskier positioning have actually sold their hedges into rising rates to show accounting gains, leaving them vulnerable to further rises in rates as well as the notion of rates staying higher for longer which they most likely will.

As a result of the banking system being under increasing pressure, we can see materially tighter lending standards across the board. Below we see that over 40% of banks have tightened lending standards for commercial and industrial loans destined for large and middle-market firms. Those same lending standards have tightened even more meaningfully for consumers and small businesses.

Shifting over to the broader market, here’s a statistic that makes me just a bit uncomfortable with concentration risk. The S&P 500 is a market capitalization-weighted index, and 21% of that weighting is from just five of the largest companies in the index. This is significantly higher than any other time except when we had the “Nifty 50” during the 1960s in the US.

When we zoom into market breadth, we can also see that there are only 32% of S&P 500 stocks outperforming the broader index, a sign of narrow breadth. This statistic is especially intriguing when we factor for 7 mega cap growth and tech stocks accounting for 90% of the year-to-date gains in the index.

This is the narrowest market breadth that we’ve seen since 2016, and it often portends to a leg lower in stock prices, as we saw during the Dot Com Bust, the Great Financial Crisis, the European Debt Crisis, the Tightening Tantrum, and COVID Crash as a selection of prior examples.

In commercial real estate, a disconcerting trend is the office vacancy rate hitting record highs. This tells me a few things. For one, I don’t think post-COVID office utilization rates will normalize. Many companies have embraced hybrid and fully remote work, downsizing their commitment to commercial office space.

The other is that many companies expanded too rapidly in the last few years, and as economic conditions become more difficult, they are shrinking their square footage. We can see it with the likes of Amazon, Google, Meta, and many other smaller firms as well. With regional banks the largest bank lenders in the commercial real estate space, this may have deleterious impacts on their loan books moving forward.

Systematic positioning in US equities is at the highest levels we’ve seen since 2021 (not seen on this chart), which tells us CTAs, combined with risk parity and volatility controlled funds don’t have much buying power left.

Recent fund flows into US equities have shown shorts covering and longs growing, with net flow being mostly positive since mid-March. Given the above and below charts, it’s very hard to say that the market is very bearishly positioned.

While some charts, taken in isolation, suggest that hedge funds are “very short”, the reality is much more complex as that is only taking S&P 500 e-mini futures positioning into consideration in vacuum. The reality is most of these funds are net long.

Tech stocks continue to trade at rich valuations, which tells me given how much rates have risen, that they are priced for perfection. It’s hard to say that these valuations are attractive given the challenging economic environment, lack of earnings growth at many such firms, and noting that many businesses and consumers are cutting spend on technology wherever possible

The trailing PE ratio of 19x is materially frothier than what we had seen during prior bear markets re-rating the risk of equities, which would mean that if a new bull market was to start at these valuations, it would be the most expensive in history, and likely provide weak returns and not last a very long time. We still believe that we are in a bear market with a challenging environment ahead of us as 2023 goes on.

Breadth inside the NASDAQ new highs vs new lows tells a similar story of remaining in a bear market environment, as there are more new lows than new highs on a consistent basis, with brief periods during bear market rallies where we see that trend reverse, only to ultimately lead to even more new lows again within the components of the index.

Of the 10 largest companies within the NASDAQ, Amazon, Alphabet, Meta, Apple, and Microsoft are big spenders on research and development, with Meta and Nvidia spending the most of their revenue (30% and 27% respectively) on the same.

Central bank gold purchasing risen to the highest level on record, demonstrating a propensity by these institutions to diversify their reserves. Gold is a hedge against uncertainty, and we are living in very uncertain times.

International value vs growth appears to be attractive, but remember that cheap can always get cheaper. That being said, in an environment of rising rates and slowing economic growth in many countries, value factor investments appear more attractive as they may have less downside risk.

Finally, looking towards history for prior bull and bear markets, we can see that the current bear market has been rather short vs prior bears, clocking in at 9 months with a 25% decline from peak-to-trough. The average bear market lasts 20 months and declines about 41%.

We hope that you enjoyed this edition of Charts of the Week from the team at MacroVisor.

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