One week before the debt ceiling deadline, members of Congress have adjourned, while a handful of negotiators continue to search for a compromise solution to the impasse. Investors are holding their breath.

 

As many expected, myself included, the politicians are drawing out the drama and will continue to do so until the 11th hour. Both sides have stressed that there will be no default and the market has taken them at their word. Investors have bid up stocks this week in anticipation of a positive announcement.

 

This week, Fitch, one of the big three American credit agencies, has put the nation's debt on a negative credit watch. The agency warned that it may downgrade the U.S. AAA debt rating to AA+ over the debt ceiling fight. It cites the increased political partisanship that is hindering a resolution to the debt limit. In addition, they point to the failure of the U.S. to meaningfully tackle rising budget deficits and a ballooning debt burden.

 

This brings back to mind a similar situation in 2011. At the time, another big credit agency, Standard & Poor's, downgraded the nation's debt to AA+ for the same reasons, despite the two sides coming to a compromise and avoiding default.

 

Politicians from both sides denounced the move, as did the U.S. Treasury, to no avail. It still has not restored its' AAA rating. The agency said their downgrade reflected their view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges. That sounds about right to me, and if anything, the environment has worsened over the last 12 years.

 

Although I have never seen a published dollar amount of the cost to the nation and the taxpayer of that downgrade, I do know that the rating downgrade increased the U.S. government's cost of capital (interest, fees, and yields). The higher costs simply reflect the increased risk lenders are taking in buying our debt. Given the trillions of dollars we have borrowed over the last dozen years, we are talking billions and billions of dollars in extra costs. And here we are again in the same situation. Will Fitch follow Standard and Poor's lead and lower the rating? Time will tell.

 

Throughout the week, yields on bonds have risen in fear of default with the one-month, U.S. Treasury bills now yielding more than 6 percent. Three-, six- and nine-month U.S. Treasury bills are yielding between 5.31 percent to 5.39 percent. The U.S. dollar has shot up as well, and that combination has savaged precious metals and most other commodities.

 

Equities have fared much better — thanks to AI and 10 large-cap tech stocks. Artificial Intelligence (AI) has been around for many years, but the idea has caught fire among traders and investors. Reminiscent of the Dot.Com boom (and bust), any stock that has even a whiff of exposure to AI has exploded higher. Nvidia, a semiconductor company that is at the forefront of chips needed in the AI space, announced spectacular earnings and even better guidance this week. The stock rose 25 percent overnight and carried the technology sectors along with it.

 

But underneath this hyped-up area, most equity sectors of the overall market were at best marking time while the debt negotiations continue. As I predicted, traders are reacting to every word and headline, moving markets up and down. The latest word out of Washington is that President Joe Biden and GOP House Speaker Kevin McCarthy are closing in on a deal.

 

Their idea is to produce a simple agreement with a few key top-line numbers for spending, including defense spending, and let lawmakers hash out the details through the normal appropriations process in the months ahead. That would dispense with a weighty, thousand-page bill that would require legislators to write, read and vote on all in a matter of days.

 

My belief for months is that a deal will get done and the market agrees, otherwise, the market averages would be a lot lower than they are right now.

 

The question to ask is what will happen after a deal is done? I expect markets will spike higher in a relief rally, but then what? The U.S. Treasury is expected to need to raise a lot of money in the form of new government debt sales in the weeks after an agreement. That should send interest rate yields higher and probably put pressure on the stock market. But let's just get through the next week first. 

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

Bears and bulls are battling for supremacy, which is keeping stocks moving in a tight range. The question is which way will the markets break?

 

On the plus side, inflation does appear to be falling, or at least not going higher. Both the Consumer Price Index and the Producer Price Index came in as expected for April. Investors interpreted the data as a bit of a positive in the fight to control inflation. The trend is definitely down compared to last year's numbers.

 

Bears, on the other hand, were encouraged by the rising fears of a default on the nation's debt in less than three weeks. In addition, the ongoing regional bank contagion is alive and well. Pacific West Bank, a regional bank, reported that almost 10 percent of deposits flowed out of the bank's doors last week.

 

The focus on corporate earnings has taken a step back now that the mega stocks have been reported. Results are still coming in better than expected overall, but guidance is checkered. Companies in some sectors are seeing a troubled future, while others claim it is business as usual.

 

Just a handful of stocks (FANG+) have been supporting the equity market for months and that still seems to be the trend. For the markets to move higher, we would need to see both an expansion of the number of stocks that are participating in an up move (breath) and overall market volume must increase as well.

 

Early last month, in a separate column on the debt ceiling, I warned that readers could expect the debt ceiling would begin to concern Washington, the media, and the financial markets. This week was the first meeting of the key players: the president, and leaders of both parties in Congress. I expect the rhetoric to escalate, and fear-mongering will move to center stage. The beginning of the horse-trading process is expected to occur early next week when both sides meet again.

 

For the politicians, it is a huge opportunity to shine among their partisan voters, to appear strong, dedicated to principles, and concerned about the country's future. They won't give up that chance until they absolutely must. That's why this bickering will drag on up to the eleventh hour or even beyond. 

 

Underneath this farce is a simple truth. Imagine a credit card bill, or mortgage payment that is due on June 1. Most people would not even blink in considering whether to pay at least the minimum amount due. Sure, you may have a discussion afterward on how to reduce your spending or refinance a mortgage, but you won't skip a payment. But in Washington politics, that argument is beside the point because it is not about the debt, it is about them and their political future.

 

The sad, sad truth is that without turmoil in financial markets, the politicians on both sides have no incentive to agree. That could mean by next week, or the week after, we can expect to see a period of downside in the markets, punctuated by spikes higher as market participants hang on every word uttered in this increasingly acrimonious debate. That could mean a 10-15 percent decline in the markets between the last weeks of May into June. 

 

I am already getting calls from concerned investors on how to manage through this volatile couple of weeks. For long-term investors, my advice is to do nothing. In the end, the debt ceiling will be passed. Those most against it now will vote for it in the end and then try and hide their vote from their constituents.

 

If you feel you will need some cash in the short term, a three-month CD could be a safe bet. The yield on those instruments is almost 5.25 percent, the last I looked, which is a great rate.  U.S. Treasury bills, notes, and bonds are also an alternative, although, with the risk of government default, some investors are shunning these instruments despite yields on the short end that are 5 percent or more.  In any case, prepare for an uncomfortable few weeks, but we will come out the other side just fine.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

The Federal Reserve Bank raised interest again, even as another regional bank saw its stock price collapse. Investors are asking when enough tightening is enough.

 

The key Fed funds interest rate was hiked by another 0.25  percent, which increased its benchmark rate to between 5 percent and 5.25 percent. That was the 10th hike in 14 months and has pushed interest rates to a 16-year high.

 

The stock market sold down after Chairman Jerome Powell made it clear (again) that fighting inflation is the Fed's number one objective. Powell did hold out some hope that this hike could be the last, although that decision, he said, would be data-dependent and be decided from meeting to meeting. Nothing he said was concrete enough for investors to truly believe that a pause in rate hikes is in the offing.

 

The bulls were hoping that the meeting would either result in no interest hike or be a one-and-done event. Neither occurred, which has ramifications for the economy, employment, and the ongoing regional banking crisis. The banks lead the market declines and well they should.

 

Beginning in March, with the collapse of Silicon Valley Bank, the markets realized that the rapid rise in interest rates had created both a danger for many banks and an investment opportunity for the public. Main Street could now buy high-yielding U.S. Treasury bills and CDs instead of keeping their money in checking and saving accounts with little to no returns. I have written extensively on the subject in my columns over the last several weeks.

 

As the Fed continues to raise interest rates, the yield on these alternative investments also rises. The yield on a three-month U.S. Treasury bill, for example, rose from 5.10 percent to 5.25 percent the day after the Fed's interest rate hike. This has had a serious detrimental impact on banks overall and regional banks as more and more investors pull their deposits.

 

But that is not all. The $5.7 trillion commercial real estate sector (CRE) is also in trouble. Thanks to high-interest rates, the Pandemic, and the subsequent trend toward working from home, many urban centers are facing a historically high vacancy rate. It is so bad that many cities are considering converting empty office buildings into living spaces.  This trend is spreading across the nation.

 

Smaller regional banks hold 4.4 times more exposure to the U.S. CRE than larger banks, according to a recent report from JPMorgan Private Bank. Citigroup also found that banks represent 54 percent of the overall CRE market, with small lenders holding 70 percent of CRE loans. Between the drain on deposits, and now the risks in real estate, is it any wonder that the regional bank index has lost 34 percent of its value over the last month?

 

Within hours after the Fed hiked rates on Wednesday afternoon, the regional bank, PacWest, reported that it was considering strategic options including a sale. The bank's stock tumbled 60 percent on Thursday and took the regional bank index and the stock market down with it. Gold, silver, and Bitcoin (all areas I have featured in the last few months) spiked higher in a rush for safety with spot gold hitting a high of $2,085.

 

As I said last week, where the market would finish the week would depend on the Fed's decision on interest rates. In hindsight, Chairman Powell had it right. The non-farm payroll data released on Friday showed that 253,000 jobs were added in April. The unemployment rate dropped to 3.4 percent, while the expectation was that the rate would rise to 3.6 percent.  The Fed wants to see job gains fall, but they are going the other way.

 

The Fed needs to see the unemployment rate closer to 4-4.5  percent percent to reach its inflation target of 2 percent. We are nowhere near that level, so to me, the Fed's stance on monetary policy seems vindicated.

 

So where does all this bearishness indicate to me? For me, I think the markets will bounce back next week. We may even break the range we have been in for almost a month. That is a contrarian call, since most traders are what I called "beared up."

 

I believe we can still see my target on the S&P 500 Index of 4,325 give or take a few points. After that, likely in the second half of the month, I believe we will see a substantial pullback. Precious metals, on the other hand, are likely to now see a bout of profit-taking after a spectacular run.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.

 

All eyes will be focused on May's Federal Open Market Committee meeting (FOMC) this week. Most investors are expecting another quarter-point interest rate increase, and there is an ongoing debate over the possibility of another one in June.

 

Some strategists believe that may be overkill. The fear is that the Fed could break something else if they do. Many already blame the Fed's rapid hiking of interest rates for the troubles within the regional bank area. The value of Silicon Valley Bank's U.S. Treasury bond holdings, for example, fell by billions of dollars as the Fed tightened monetary policy over the last year.

 

And the banking worries continue. This week, a large San Francisco-based bank, First Republic Bank, saw its stock lose 95 percent of its value. In announcing first-quarter earnings results, First Republic admitted that it had lost more than $100 billion in deposits in the first quarter.

 

The collapse of SVP and Signature Bank had prompted a run on its deposits as well. Last month, in a bid to stabilize the bank, a group of 11 big banks deposited $30 billion with the beleaguered institution hoping it would solve the problem. Those hopes have been dashed.

 

First Republic's main business is making large mortgages at low rates to well-heeled borrowers. As such, the bank is buried under a mountain of mispriced loans as interest rates have spiked higher over the last 12 months. To raise cash, they would have to sell off those loans to others at substantial losses, which would only hasten its collapse. U.S. officials are coordinating urgent talks with private-sector banks to come to the rescue. If a deal isn't struck soon the fate of First Republic seems dire at best.

 

In any case, it is not hard to understand why the fear of breaking something else is quite real right now. This week, the Fed will likely raise rates again. As interest rates continue to rise, no one knows how exposed other entities in the financial sector might be. It has put the Fed in between a rock and a hard place.

 

Inflation has not come down far enough to convince the Fed to ease its monetary stance. The most recent Personal Consumption Expenditures Index (PCE), which is the Fed's favorite inflation measure, came in as expected, just a bit cooler. In the past, the Fed has made the mistake of easing prematurely, only to raise rates again as inflation reversed and climbed higher. Better be sure, than sorry would about sum up the Fed's policy right now. 

 

But being sure raises the risks of breaking something, which could have a severe impact on the economy or parts of it like the financial sector. The U.S. economy grew at only a 1.1 percent rate in the first quarter. That was far below the consensus forecasts of 1.9 percent. In the previous two quarters, the economy grew at 2.9 percent and 3.2 percent respectively. It seems clear that the Fed's actions are having the desired effect but is it enough to even pause their rate hikes? That is the question investors are asking.

 

So far, the Fed has assured us that they have the tools to handle both the problems in the regional bank area, as well as the inflation threat. Some think that kind of thinking smacks of overconfidence. One additional issue that is raising its ugly head is the potential summer debt crisis in Washington.

 

The Republican-ruled House has passed a debt reduction package that, if passed, would make deep inroads into the Biden Administration's spending programs. That is their price for increasing the debt limit. The proposal is deemed dead on arrival by the Democrat-held Senate, however. As I have written in the past, in my opinion, the entire issue is simply political theater, with the fate of the nation's credit at risk.

 

If history is any guide, the closer we come to the cliff of default, the more both the bond and equity markets will come unglued. It might require actions by the Fed to calm markets and ensure orderly markets. That could disrupt the central bank’s tightening plans in the months ahead.

 

Marketwise, the volatility I expected last week has kept the indexes in a trading range. We ended the week a little above where we started. First quarter earnings results so far were better than expected. A handful of large-cap companies (Microsoft, Meta, Google, and Amazon) delivered more positive results than negative. The coming week will be all about the FOMC meeting on Wednesday and Apple results on Thursday. The chop should continue, but I am still looking for higher in the short term.

 

First-quarter corporate earnings are pouring in, and the results have been mixed. So far, the numbers have been good enough to keep the market from falling significantly, but not good enough to warrant further gains.

 

It is still early days, with only 15 percent of companies reported, but so far, the best I can say is mixed. The multicenter banks continued to surprise to the upside this week, while the regionals have been so-so but not as bad as some expected. Of course, the Silicon Valley Bank debacle did not occur until toward the end of the quarter, so much of the impact won't be known until the second quarter results are announced.

 

Tesla, one of the cult favorites of many in the markets, was disappointed. That threw the markets into a funk, at least on Thursday and Friday. The electric vehicle market is in the throes of a price-cutting war globally, which Tesla started. The EV leader has cut prices 5 times on its vehicles since the beginning of the year. They did so as the global economy slowed. The company wants to not only maintain its worldwide market share but expand it as well.

 

In China, the price war is particularly ferocious where competitors such as Nio Inc, XPeng Inc. and BYD Co. Ltd. are selling some EV models at a 50 percent discount to prices in the U.S. and Europe. This, as you may imagine, is having an impact on Tesla's profit margins and thus the disappointing earnings results.

 

The prevailing sentiment right now is that while the economy may be slowing, the Fed is still hell-bent on raising rates another 25 basis points at their May meeting. After that, some expect a pause, while others disagree. It will depend on the data, in my opinion.

 

We will be getting another reading on inflation in the coming week (April 28) when the Personal Consumption Expenditures Price Index (PCE) is reported. The PCE measures the prices paid for goods and services and it is a data point that the Fed watches carefully.

 

Economists and the Fed will be paying special attention to the services side of the report where inflation has been sticky. A hotter number may convince the Fed that a pause in their tightening program may be premature. As such, investors will likely assign great importance to the PCE print. 

 

What many investors fail to realize is that even as the Fed continues to tighten, liquidity in the financial markets is rising. The contradiction can be explained by the U.S. Treasury's actions in the face of the nation's fast-approaching debt limit. The government can no longer sell Treasury bonds as it has in the past without triggering that limit prematurely.

 

Instead, the Treasury has been spending down its checking account, called the Treasury General Account. That adds money to the system in two ways. With fewer bonds able to be purchased there is more cash looking around for a home. Second, the cash disbursements from the Treasury General account also inject additional liquidity directly into the system.

 

In addition, the recent regional bank issues (Silicon Valley Bank, etc.) have forced the Fed to also increase liquidity to the banking system. Taken together, there is now more money sloshing around the system than many realize.

 

A lot of that money flows into other assets in the financial markets (like the stock markets), at least in the short term. At some point this summer, when the new debt limit is finally passed in Congress, that situation will reverse but, in the meantime, it helps explain why the stock market has been resilient in the face of rising interest rates, a slowing economy, and inflation. I look for the stock market to continue to fluctuate in the week ahead.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.