Banking lending trends will tighten as credit proves to be ‘bloodline of the economy’: Analyst
Truist Co-Chief Investment Officer Keith Lerner discusses Treasury Secretary Janet Yellen’s comments on the U.S. banking system, Fed rate hike expectations, and the ongoing bank pressures on markets.
SEANA SMITH: Keith, it's great to see you. so before we get to the Fed and the expectation there, I want to start with how the market has been behaving over the last couple of weeks because despite the chaos that's been going on in the banking sector, the market has remained pretty resilient. The S&P closing up 1 and 1/2% last week. What do you attribute this to?
KEITH LERNER: Yeah. Well, great to be with you, Seana and Dave. You're right. I mean, the market last week was up 1%, 1.4%. Part of this is-- first thing is from a technical level, the 3,800 level found support. So investors stepped in at 3,800 level. So that's a positive. The other thing is when you look at the overall market, you have to look underneath the market to see really what's happening. And last week, what you saw is big cap growth, which is a bigger part of the overall S&P, was up 5%. Think about technology, communication services. And that more than offset some of the weakness we were seeing in more of the financials, banking stocks, and also energy and materials.
And then this week, we're actually seeing a bit of a rebound of those beaten up areas as well. So listen, all in all, I think what the Fed did, as far as providing the backstop, has helped provide some confidence for the market. That said, you know, I know a lot of folks are waiting for it, the Fed, as you mentioned. And I know you have some questions on that, but we don't think that's a panacea, even if they cut rates-- I mean, sorry, even if they pause tomorrow.
DAVE BRIGGS: If they do raise tomorrow, Keith-- and the belief is probably a 25 point hike-- what will the markets, how will they respond?
KEITH LERNER: Well, right now, you know, I think that if you look at the Fed funds futures, that the high probability is still a 25 basis point move. I think it's going to be more important what Powell says in the press conference. And that's often been the case and how much he acknowledges some of the financial strains. And also, is it going to be a dovish hike insofar as that he discusses that they're on hold thereafter? So, historically, when we look at these rate cycles, you typically do get some type of rally. I think that's part of the reason why the market's rallying today.
However, I will say this. Whether the sustainability of any rally is really dependent on where the economy is going, our view is that there are still elevated recession risk into the back half of the year. So if we do get any type of rally, we would be fading that rally, especially anywhere in the 4,100 to 4,200 level. And the reason being simply is even today, we're trading around the 10-year average valuation for the market. Our point of view is there's above average macro risk at this point. So we just don't think you're being compensated for taking on a lot of risk today.
SEANA SMITH: Keith, when it comes to maybe investors looking to take on risk, lots of people are looking at the activity that we certainly have seen in the banking sector. Treasury Secretary Janet Yellen responding to whether or not the current banking crisis that we are seeing, how that relates to 2008. Obviously, she made the point that it's very different. Let's take a listen to what she had to say. Then I want to get your reaction.
JANET YELLEN: Well, we don't yet have all the details about the collapse of the two banks. We do know that the recent developments are very different than those of the global financial crisis. Back then, many financial institutions came under stress due to their holdings of subprime assets. We do not see that situation in the banking system today. Our financial system is also significantly stronger than it was 15 years ago.
SEANA SMITH: Keith, how are you looking at the recent activity in the banking sector and potential investment opportunities there?
KEITH LERNER: Yeah, well, the first thing, I do agree this is a lot different in 2008. Actually, I took over as the chief market strategist right late in 2007, so I lived through every tick of the financial crisis. And as mentioned by Chair Yellen, is that that was a credit crisis with a lot of bad loans. This is a liquidity crisis with, actually, holdings of really high quality paper. So I think it is different in that respect.
But either way, I think from our perspective, before this, bank lending trends were becoming tighter already. So after what happened the last few weeks, our view is bank lending trends are only going to become more tighter going forward. And that's important insofar as that credit is the bloodline of the economy. And we think that the economy was likely already to slow because all these Fed rate hikes over the last year still haven't fully filtered into the economy. And this will only make things somewhat tighter.
So even as you've seen the market rally and the 10-year Treasury come in, credit spreads have actually widened somewhat. So from my point of view, this is still-- we're going to have some challenges ahead. And then more specific to your question on financials, after you have a shock period in a sector like we've just seen, typically, what you have is a tug of war between fear and greed for a while. And you have a lot of back and forth without a lot of traction. So, in our view, with finances, we're neutral at this point. And we think it's going to just take some patience in that sector.
DAVE BRIGGS: A lot of patience based on some charts you sent over to us. You mentioned taking over in that 2007 period in which Fed rates were falling, but stocks weren't rising with those falling rates, similar to what we saw in that 2000 to 2000 period-- 2000 to 2002 period. When will we see rate hikes begin to fall? And do you expect a similar performance from the markets?
KEITH LERNER: Yeah, well, there's a lot of that. I talk to a lot of institutions and even some of our clients. There's this discussion that, hey, the Fed pivots. The market's off to the races. And to the point you just brought up is that, historically, if you do go into recession, just cutting rates doesn't necessarily end the recession or is a boost to the market. The times people remember where a pivot really helped was 2019 or 1995, which wasn't-- which where a recession did not occur later on. We think recession risks are relatively high.
So if the economy does weaken later in this year, we expect to see likely at least one or two rate cuts later this year. But the market was getting ahead of itself in our view, pricing in about three rate cuts. And the other thing is, if we get more than the two rate cuts or three or four, in our view, that's likely because the economy is even weaker. And that's going to head corporate profits. So for a lot of folks, we're waiting for aggressive rate cuts. We don't know that's necessarily the best thing for the overall market. And that's one of the reasons we remain overall somewhat more defensive.
DAVE BRIGGS: Indeed. All right, good stuff there. Keith Lerner, Truist. Always good to see you, my friend. Thanks.