First Republic Bank’s
failure and takeover by JPMorgan Chase is the latest indication that the strains from rising interest rates are just beginning to show themselves—a reason Gavekal Research analysts on Monday suggested investors be wary of bank stocks, small-cap stocks and cyclical stocks.
The failures of First Republic (ticker: FRC), Silicon Valley Bank and
Signature Bank
will likely add to the exodus of deposits from U.S. commercial banks as savers seek out better yielding money-market funds. That exodus is aggravating the credit crunch already beginning to unfold—and will continue to do so as U.S. commercial banks try to deal with rising funding costs by selling less profitable assets, writes Gavekal analyst Tan Kai Xian in a client note.
The result: Fewer banks able to make new loans—a reason investors should assess what in their portfolio could be most vulnerable as lenders become more conservative with their reserve assets and interbank borrowing costs rise.
While some have spotted an opportunity amid the turmoil in banks, Xian sees the possibility bank stocks are value traps. The exodus of deposits, an inverted yield curve and worsening asset values are putting pressure on bank profits. The Financial Select Sector SPDR Exchange-Traded Fund (XLF) is down 7% since early March to $33.33.
Small-cap companies may also fare worse than larger-cap companies since they rely more on bank credit. “With the Fed likely to stick to its inflation-fighting mantra—thus worsening the credit crunch—underperformance by small-caps should continue. Small-caps are also most exposed to the domestic economy, and so will be hit hardest if the U.S. tips into recession,” he adds.
Elsewhere in the market, Xian favors underweighting U.S. industrials and technology stocks versus more defensively oriented utilities for now, noting that cyclicals tend to track U.S. economic growth tightly and a worsening credit crunch will hurt U.S. housing and business investments, which only increases the odds of a recession.
The Vanguard Industrials ETF (VIS) is down 4% to $188.55 since early March, compared with while the Vanguard Information Technology ETF (VGT) is up almost 7% to $384.99 over that same period. The
Vanguard Utilities ETF
(VPU) is up 3.5% to $149.73.
But within that potential weakness of a recession, others see an opportunity amid select industrials—specifically those that could benefit as companies try to diversify their supply chains away from relying on China and moving some product closer to home and companies look to bolster productivity.
In a note to clients, BofA Equity and Quant Strategist Savita Subramanian writes that quarterly earnings calls were rife with talk about “efficiency” as companies try to offset the hit from labor shortages and a need to diversify their supply chains, often to pricier parts of the world.
Subramanian sees an increase in spending on automation and artificial intelligence as companies try to preserve their margins—and that could be a boost to industrial and technology companies geared toward “new economy” capital spending.
That said, Subramanian also sees more pressure ahead for the tech-heavy S&P 500, which could still see further declines—a reason she favors the equal-weighted S&P instead.
Write to Reshma Kapadia at reshma.kapadia@barrons.com
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