MORAM Capital - Week in the markets

The Week in the Markets – Moram Capital

The first week of the year saw the S&P 500 records a decline. In fact, it has been a strange week, with a lot of volatility (the VIX, in fact, is among the winners of the week), where surprisingly, small caps have been the best performers of the week. We say surprisingly because the week was mainly marked by the US CPI data, which came out at 3.9% instead of the expected 3.7%, initially hitting small caps hard (we’ll discuss this 3.9% later), but they later regained ground helped by poor consumption data (which suggests that inflation will continue to decrease in the coming months).

Markets liquidity FED

As an anecdote, since 1952, the stock market has risen in electoral years when the current US president was running for re-election. The belief that monetary stimuli lead citizens to vote wisely goes back a long way…

Highlights of the week

  • Credit markets: the market was boosted by the positive reception of the U.S. Treasury Department’s $42 Bn auction of 10Y notes, easing concerns about record borrowing levels pushing up costs (higher cost would diminish some of the FED to cut interest rates if needed to stimulate the economy in the coming months). Also it was not a good week for the investment grade corporate bond market as regional bank bonds remained under pressure because of their exposure to the commercial real estate market (We are planning a detailed article to explain what is going on in CRE)

  • Commodities (Oil) : Strong recovery from last week losses as hopes of a truce between Israel and Gaza belied, the firing by Houthi rebels has also become more aggressive. and it is expected that Israel will also intensify its attacks on Rafah. The other trigger for crude oil prices came from the GDP growth estimates. The lates update of the World Economic Outlook by the IMF has upgraded world GDP growth for 2024 by 20 bps. More importantly, the biggest upgrades are coming from the key consumers of oil like China, the US and India

  • Commodities (Natural gas): Another tragic week for Natural Gas; in the US, production remains at maximum levels, and in Europe, there is not even the slightest hint that this winter resembles a real one.

  • Bitcoin has rebounded to the $48,000 level thanks to a significant increase in ETF inflows during this week. In fact, excluding the outflows from January 18th to 24th, there have been net inflows almost continuously since its launch. February 8th marked the second-highest inflow since the launch.

Bitcoin ETF inflows
  • Good week for emerging markets led by China whose central bank pledged to maintain flexible policy support to stimulate domestic demand, anticipating a modest rebound in consumer prices amid challenges including a property market downturn and weak consumer demand (CPI fell sharply, led by declining food prices, while PMI marked its 16th consecutive month of deflation.) India, South Korea and Brazil (among the 3 represents more than 35% of the index) also advanced this week.

 

4Q23 Earning Season

  • Chipotle’s 4Q23 results surpassed expectations: EPS reached $10.36 versus an estimated $9.75, while revenue totaled $2.52 billion ($2.49 Bn estimated). Comparable sales rose by 8.4%. Operating margin increased to 14.4% from 13.6%, with restaurant level operating margin reaching 25.4%, up by 140 basis points. FY23 was a record year for Chipotle, marked by a record number of new restaurant openings, surpassing $3 million in AUVs, and forming their first international partnership. For 2024, management anticipates mid-single-digit growth in comparable restaurant sales, and 285 to 315 new restaurant openings.

  • McDonalds: 4Q23 results showed strong earnings and revenue growth but missed expectations due to weakness in the Middle East, China, and India. with EPS at $2.80 (up from $2.59 y/y) and revenue at $6.41B (an 8.1% increase y/y). However, comparable sales missed estimates: +3.4% overall, +4.3% in the US, +4.4% in international operated markets. Its shares fell -2.57% this week.

  • Flex LNG shares suffered a steady decline this weak after reporting a weak 4Q23. Vessel operating revenues were $97.2MM (increasing QoQ) but net income fell to $19.4MM ( $0.36 EPS).. The average TCE rate for the fourth quarter was $81,114 per day. Company is maintaining its $0.75 quarterly dividend but anticipating a more challenging freight market due to increased ship deliveries compared to expected new export volumes. (They have 94% charter coverage for 2024)

  • Spotify 4Q23 results, Spotify saw notable growth, with revenue reaching €3.671 billion, up 16% year-over-year. Despite reporting a negative income of €75 MM, the company achieved a significant FCF of €396 MM, and its Gross Margin rose to 26.7%. The user base expanded, with MAUs reaching 602 MM and Premium subscribers totaling 236 mm.

    Looking ahead to 2024, Spotify aims to add 16 MM MAUs and 3 MM Premium Subscribers. The company expects to maintain revenues at fourth-quarter levels, partly due to a 2.5% currency exchange impact, with similar margins anticipated and a return to profitability expected

Macro data

A quiet week in terms of economic data, which has allowed for the digestion of last week’s data.

United States

  • ISM Non-Manufacturing PMI- act: 53.4, exp: 52, prev: 50.5

  • Services PMI (Jan)- act: 52.5, exp: 52.9.4, prev: 51.4

  • Initial jobless claims: 218K vs (221k Expected & 227K previous) – The labor market remains very strong (this topic was discussed in detail during the interview with GTIM – focusing on the restaurant industry).

Europe

  • UK composite PMI 52.9 vs 52.5 expected, 51.9 previous (UK services activity rises at fastest pace in 8 months)

  • UK Services PMI 54.3 vs 53.8 expected and 53.4 previous

  • UK House price index (YoY) 2.5% vs 1.8% previous

  • German CPI 0.2%, expected 0.2%, previous 0.1%

Rest of the World

  • Chinese new year celebration from Thursday till Monday 19th February (stock market will be close all these days)

  • Australia maintains interest rates at 4.35%

Zoom of the Week – US Regional banks

A few weeks ago, on January 25th, the Fed announced that on March 11th, it would end the emergency bank funding service (BTFP), which since March 2023, had safeguarded troubled regional banks.

This service, called BTFP (Bank Term Funding Program), is designed to provide liquidity to eligible depository institutions such as banks, savings associations, credit unions, and others, ensuring they can meet the needs of all their depositors.

The program offers loans with maturities of up to one year, using high-quality assets as collateral such as US Treasury bonds, agency securities, and agency mortgage-backed securities, which will be valued at par to avoid the need for institutions to quickly sell these securities in times of financial stress.

From late March 2023 to November, BTFP usage increased slightly and steadily. However, starting in mid-November, it surged to $167 billion because the rate allowing borrowing funds for up to a year was lower than the interest on reserve balances. In other words, banks were engaging in arbitrage and benefiting from it.

With the announcement of the end of BTFP on March 11th, 2024, the Fed also completely eliminated the possibility of arbitrage, and BTFP usage has normalized.

 

The important question we must ask now is, has the situation of regional banks improved during this year to the point where they no longer need BTFP?

Interest rates have increased from 4.50%-4.75% in March 2023 to 5.25% – 5.50% by March 2024. Meanwhile, the unrealized banking losses of US banks at the end of the third quarter of 2023 (the last known data) amounted to $684 billion.

The issue is that these unrealized losses drastically reduce a bank’s liquidity. And as shown in the following graph, the situation of small banks (reserves / total assets) without BTFP is even worse than in March 2023. Unlike large banks, which have improved their situation.

Regional Banks

Therefore, as we approach March, several possibilities emerge:

  1. Reinstating BTFP by the Fed, or another similar facility, possibly by the Treasury.

  2. Encouraging troubled regional banks to be acquired by larger banks, leading to further bank consolidation.

Another point affecting regional banking, which has recently caused concern, is commercial real estate (CRE):

  • More than $1 trillion in commercial real estate loans are scheduled to mature before the end of next year.

  • This presents a significant problem as these properties have lost much of their value (especially offices, with losses nearing 40%), and many property owners could be forced to sell if they cannot refinance their debt due to less favorable market conditions.

  • US regional banks are particularly exposed to this problem, representing nearly 70% of all outstanding commercial real estate loans.

  • With property values declining, these banks face the risk of dealing with significant holes in their balance sheets if property values continue to fall and loans default.

  • The graph shows commercial real estate (CRE) reserve ratios among banks, organized by regulatory category (classifications used by regulatory authorities to assess and supervise banks based on their size, complexity, and risk).

     

In general, outside of Category 1 and 2 (which have limited exposure to CRE), the larger the bank, the higher the reserves it holds against its CRE loans.

Week in the market - regional banks

In summary, the termination of the Federal Reserve’s Emergency Bank Funding Program (BTFP) on March 11, 2024, raises concerns about the stability of regional banks in the U.S., particularly in a context where interest rates remain high and significant unrealized bank losses exist. Smaller banks appear more vulnerable, especially in the face of imminent challenges in the commercial real estate sector, where a large number of loans are nearing maturity and property values have decreased. This situation may require additional measures to ensure the resilience of the regional banking sector and to prevent macroeconomic strains in such an important election year.

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