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Bank Stress Continues Despite Rising Rates

Introduction

Last month’s bank failures led to a lot of panic in the banking industry. However, some of the big banks managed to hold up due to rising rates. This helped the Dow industrials to close out its longest weekly winning streak since October. As earnings season gets fully under way, is banking stress done?

The Warning from Morgan Stanley’s chief U.S. equity strategist Mike Wilson

In a new note, Morgan Stanley’s chief U.S. equity strategist Mike Wilson warns of a long shadow cast by March stress, despite a mostly upbeat stock market. Wilson tells his clients that bigger indexes are being held up by “defensive/high-quality characteristics and lower back-end rates”. However, he warns against breathing easy as “the gradual deterioration in the growth outlook continues, which means even these large-cap indexes are at risk of a sudden fall”. To put his point across, Wilson uses a quote from one of Ernest Hemingway’s novels: “Two ways…Gradually, then suddenly.”

The Fallout

Last month’s bank failures were blamed on a gradual build-up of risk from long-duration treasury holdings and concentrated deposit over the past year which suddenly accelerated. Due to this, investors now need to stay alert for more fallout, warns Wilson. One area to watch is earnings and a “gradually, then suddenly,” decline in estimates. This decline has fallen by around 9% per annum since last June’s peak, which is not severe enough for equity investors to demand the higher equity risk premium that Wilson thinks they should.

Wilson is neither swayed by consensus earnings forecasts that imply the first quarter will mark an EPS trough – usually a buy signal. Last week’s bigger-than-inflation drop in profit may pose trouble for companies as it hints of sagging demand. “Inflation is the one thing holding up revenue growth for many businesses,” says Wilson. If/when revenues begin to disappoint, that margin degradation can be much more sudden, and that’s when the market can suddenly get in front of the earnings decline we are forecasting, too.”

Market Updates

The markets are struggling but still hint that Wall Street may start near record highs. Oil prices are tilting lower. Charles Schwab is up after posting an earnings beat, while M&T Bank is up 3% and State Street shares are down 8%. Upbeat guidance is also lifting shares of Amneal Pharmaceuticals. Xpeng shares are up 11% after the China-based EV maker unveiled a new production platform, taking Nio and Li Auto shares along for the ride. Prometheus Biosciences is soaring 70% after pharma group Merck said it would buy the clinical-stage biotech company. Infosys shares plunged last week stemming from the IT tech outsourcing group’s gloomy results.

The Buzz

The Empire State manufacturing index surged to its first positive reading in five months last week. A speech by the Richmond Fed President Tom Barkin is expected. The rest of the week will see Bank of America, Goldman Sachs, and Netflix report. Tesla and Morgan Stanley are also expected to report this week.

Conclusion

The banking industry has faced a lot of stress due to last month’s failures. However, bigger banks managed to hold up due to rising rates. Despite this, Wilson warns of a long shadow cast by March stress, which means even these large-cap indexes are at risk of a sudden fall. Investors need to stay alert for more fallout as the gradual deterioration in the growth outlook continues.

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Bank Stress Continues Despite Rising Rates

The banking industry has been facing a lot of stress due to the failures of banks last month. However, some of the big banks managed to hold up due to rising rates. This helped the Dow industrials to close out its longest weekly winning streak since October. As earnings season gets fully under way, is banking stress done?

In a new note, Morgan Stanley’s chief US equity strategist Mike Wilson warns of a long shadow cast by March stress, despite a mostly upbeat stock market. What we learned from last week’s event is that some big banks are holding up okay after last month’s tremors. With cooling inflation, the Dow industrials close out its longest weekly winning streak since October.

The markets struggle, but still hint at Wall Street starting near record highs. Oil prices are tilting lower. Charles Schwab is up after posting an earnings beat, while M&T Bank is up 3%, and State Street shares are down 8%. Promoteus Biocsciences is soaring 70% after pharma group Merck said it would buy the clinical-stage biotech company. Infosys shares plunged last week stemming from the IT tech outsourcing group’s gloomy results.

Last month’s bank failures were blamed on a gradual build-up of risk from long-duration treasury holdings and concentrated deposit over the past year which suddenly accelerated. Due to this, investors now need to stay alert for more fallout, warns Wilson. One area to watch is earnings and a “gradually, then suddenly,” decline in estimates. This decline has fallen by around 9% per annum since last June’s peak, which is not severe enough for equity investors to demand the higher equity risk premium that Wilson thinks they should.

Wilson is neither swayed by consensus earnings forecasts that imply the first quarter will mark an EPS trough – usually a buy signal. Last week’s bigger-than-inflation drop in profit may pose trouble for companies as it hints of sagging demand.

The banking industry has faced a lot of stress due to last month’s failures. However, bigger banks managed to hold up due to rising rates. Despite this, Wilson warns of a long shadow cast by March stress, which means even these large-cap indexes are at risk of a sudden fall. Investors need to stay alert for more fallout as the gradual deterioration in the growth outlook continues.