Stocks ended the trading day higher on Thursday June 7th, and according to mainstream media the S&P 500 index has officially entered a new bull market. The Federal Reserve began their hiking campaign over a year ago on March 16th, 2022, to tame inflation. Over the past year, the Fed has hiked interest rates by 500bps and expects peak levels of 5.6% in 2023, instead of the previous 5.1% terminal projections. The S&P 500 Index has risen six consecutive sessions boosted by slowing inflation which was reported on Tuesday in addition to the Fed’s decision to leave rates unchanged in June. The major change this week in stocks has been the broadening out of gains in sectors other than technology.
S&P 500 Index (SPX) 6-month daily chart
Higher borrowing costs have begun to affect companies of all sizes. Even Apple has started delaying bonuses and reducing hiring plans to keep costs under control. Most companies have more debt than cash, so higher interest received on cash will not cover increased borrowing costs. The current environment is forcing companies to find solutions to a higher cost of capital.
Has the pressure been taken off Banks in this new bull market? The short answer is no. Elevated interest rates will continue to hurt the economy, pressure the value of bank collateral, and slow lending. In addition, the risk to commercial real estate remains elevated as large numbers of loans must be refinanced over the next few years, a significant portion of which are on the balance sheets of the small regional banks. JP Morgan estimates that 20% of commercial mortgages, to be refinanced this year, will default. The small regional banks have been deeply affected with profit margins reduced as they are forced to pay customers higher interest on their deposits to keep further capital from fleeing. In the previous low-rate environment, banks were making 3-4% on their deposits, but now must pay them between 3 and 4% on their money to keep assets from fleeing. The big banks, who pay little to no interest to their customers, are seeing higher margins compared to the small regional banks, along with increased inflows from clients leaving the smaller banks.
Since inflation slowed in May, the Fed had cover to not raise rates on Wednesday, a pause for the first time in this hiking cycle. However, Fed Chair Powell pointed to more rate hikes coming, with the next rate hike likely to resume in July. A year into the current tightening cycle, the economy has been slowing and real GDP has declined. The debt ceiling crisis concluded yet student loan payments are to resume in the next quarter. We will see in real time how this change impacts consumer spending across the country.
How sustainable is this new bull market? Only time will tell, yet having a disciplined approach can help prevent one from making emotional decisions as we navigate these uncertain times.