Conversation with a friend; WSJ articles on First Republic; Commercial Real-Estate Woes Run Deeper Than in Past Downturns; Corporate Insiders Step Up Stock Buying After Banking Turmoil; 5 Ways Pets Help with Stress and Mental Health
1) I had an interesting conversation this morning with a well-known money manager whose views I respect greatly...
To my surprise, he said he has turned moderately bullish for the first time in a while because he agrees with me that there's no banking crisis – just a few banks that got out over their skis.
He expects to position his fund more defensively once again later this year, however, because he thinks inflation is going to turn around and start rising... forcing the Fed, after a pause this summer, to raise rates rather than cut them – which is what the market is expecting.
My view is the exact opposite – that inflation will continue to fall (though not to the Fed's target of 2%... I expect it'll be in the 3% range by year end) and that the Fed will cut rates twice in the last months of the year.
This is what makes markets!
2) I just saw some interesting articles in the Wall Street Journal...
Here's the first: First Republic Lost $100 Billion in Deposits in Banking Panic. Excerpt:
Deposits fell more than 40% to $104.5 billion at the end of the first quarter, from $176.4 billion on Dec. 31. The first-quarter tally includes $30 billion from megabanks including JPMorgan Chase (JPM) meant to keep First Republic afloat, suggesting last month's panic cost the bank around $100 billion in deposits.
First Republic's profit fell 33% in the first quarter to $269 million from $401 million a year earlier. Revenue dropped 13% to $1.2 billion. Most of the quarter happened before the deposit run forced the bank to take on expensive loans from the Federal Reserve and Federal Home Loan Bank, which is likely to crimp future earnings.
First Republic is "working to restructure our balance sheet and reduce our expenses and short-term borrowings," finance chief Neal Holland said in a statement. First Republic will reduce head count by 20% to 25% and slash executive pay, the bank said. Executives declined to answer questions on a call with analysts Monday.
Boy, I got this one wrong, as First Republic Bank (FRC) tumbled nearly 30% this morning. As I wrote on March 17:
A tiny number of institutions – you can count them on one hand – had flaky deposits and mismanaged the duration and interest rate risk of their investments... and thus paid a steep price.
Yawn...
I don't think First Republic is one of those institutions, so I think its stock – which is cratering today – is one of the most interesting speculations I've seen in quite a while.
I use the word speculation rather than investment because a panic (no matter how irrational) could bankrupt it, so the outcome for the stock is likely to be bimodal – either a zero or a double in short order.
My view on FRC is captured in this WSJ "Heard on the Street" column: First Republic Joins the Living Dead. Excerpt:
To rebuild its profitability, First Republic has to start shrinking its balance sheet and paying down that expensive funding, which is what it said it would do on Monday. How exactly it will get there is less clear: Many securities or loans on its balance sheet could likely be sold only at a steep discount, generating losses.
On a conference call with analysts, Chief Executive Michael Roffler said the company is moderating loan volumes and focusing on loans that it can sell in the secondary market. Loans made in this way won't stay on the balance sheet, and the proceeds from their sale can go to debt reduction. Remaining loans and securities on the balance sheet would have to roll off as they mature.
It is far from clear how long this process may take, and management gave no indication of this on its brief call, which included no opportunity for analysts to ask questions. Without any way to gauge the pace of improvement, investors have a tough task assessing the true value of the bank.
While the worst fears have been allayed, First Republic's stock doesn't have a clear path to recovery until that changes.
3) This front-page WSJ story highlights the woes in the commercial real estate sector: Commercial Real-Estate Woes Run Deeper Than in Past Downturns. Excerpt:
Commercial real estate has experienced its share of busts in recent decades. This one is different.
Landlords are contending simultaneously with a cyclical market downturn and with secular changes in the way people work, live and shop. The sudden surge in interest rates caused property values to fall, while the rise of remote work and e-commerce are reducing demand for office and retail space.
Investors and economists say these two forces haven't come together on this scale since the 1970s, when a recession followed surging oil prices and a stock-market rout while new technologies enabled jobs to move out of major cities. This time, the pandemic is largely responsible for accelerating the commercial property upheaval.
The U.S. office vacancy rate reached a milestone in the first quarter when it rose to 12.9%, exceeding the peak vacancy rate during the 2008 financial crisis. Despite low unemployment, that figure marked the highest vacancy rate since data firm CoStar Group Inc. began tracking it in 2000.
It is unknown how bad the commercial property downturn will get. Some analysts say it may well end up less severe than the previous two downturns, in the early 1990s and after the 2008 financial crisis, especially if the U.S. economy avoids a deep recession and interest rates start to come down quickly.
But the deeper problems facing office and certain retail landlords mean building values are less likely to rebound to new highs the way they did after those previous meltdowns.
Here's a similar article from the front page of the business section of today's New York Times: A Bleak Outlook for Manhattan's Office Space May Signal a Bigger Problem. Excerpt:
New York City's biggest corporate landlords had it great for years – benefiting from a booming economy in a city where companies clamored to set up offices and from low interest rates that buoyed the economics of an industry built on debt.
Those days are over. Three years into the pandemic, floors of office buildings throughout Manhattan have been emptied by tenants who have shrunk their footprint and employees who work from home.
Now, there is another problem.
Rapidly rising interest rates have intensified concerns that the New York City office market, the largest in the country and a pillar of the city's economy, could be at grave risk. That one-two punch could be worse than anything corporate landlords have experienced before, experts on the sector say, leading major banks and real estate analysts in recent weeks to warn that languishing properties along with falling property values and higher borrowing costs could increase the odds of a recession nationally and a budget crisis for the city.
More than two-thirds of all commercial real estate loans are held by small- and medium-size banks, prompting concern that regional banks might be unable to withstand a wave of defaults if landlords cannot pay off loans. Some analysts have forecast a dim future for city centers, likening the crisis to the slow death of many American shopping malls.
I tend to agree with the bearish outlook in these articles... which is why I'm not bottom-fishing among the beaten-up shares of office REITs like SL Green Realty (SLG) (near a 14-year low), Vornado Realty Trust (VNO) (near a 30-year low), and Empire State Realty Trust (ESRT) (near an all-time low).
4) Despite the woes of First Republic and the office REITs, I remain bullish on the out-of-favor banking sector... especially the five stocks I recommended last week in the latest issue of our Empire Investment Report newsletter. I think all of these are classic "babies thrown out with the bathwater" situations.
(Subscribers can access the full issue right here. If you aren't a subscriber, you can learn more about Empire Investment Report and find out how to gain instant access to all five of these new recommendations by clicking here.)
I'm also glad to see insiders share my bullishness: Corporate Insiders Step Up Stock Buying After Banking Turmoil. Excerpt:
The recent uptick in insider buying, particularly in the financial sector, signals corporate optimism in the wake of banking-sector turmoil, providing some reassurance to investors as stocks bounce from last month's lows. The major U.S. stock indexes have proved fairly resilient after March's tumult, with the S&P 500 up 7.7% in 2023, though the index slipped last week...
Last month, officers and directors at financial firms made up more than half of all insiders who bought company stock, the highest share for the sector in at least two years, according to the Washington Service.
Insider buying in March was concentrated in regional banks, according to investment-research firm VerityData...
Eric Diton, president and managing director of investment advisory firm the Wealth Alliance, said the rush of stock buying from bank insiders confirmed his belief that the banking crisis is contained. He said he has an optimistic outlook on U.S. equities and is especially positive on dividend-paying stocks as he anticipates interest rates could soon ease.
"I'm a big fan of watching what corporate insiders do. This is not 2008," Mr. Diton said, referencing the financial crisis.
5) Today is the 13th anniversary of the day we got Rosie the Wonder Dog:
Having her become part of our family changed us all for the better – seriously! At the time, our daughters were 14, 11, and eight years old. Our older two fought quite a bit, which would cause me to lose my temper and things would often get ugly. But when we had Rosie to pet and cuddle with, it lowered the temperature in our household.
And we're not alone... According to this article, 5 Ways Pets Help With Stress and Mental Health:
Studies show that dogs reduce stress, anxiety, and depression; ease loneliness; encourage exercise; and improve your overall health. For example, people with dogs tend to have lower blood pressure and are less likely to develop heart disease. Just playing with a dog has been shown to raise levels of the feel-good brain chemicals oxytocin and dopamine, creating positive feelings and bonding for both the person and their pet.
Best regards,
Whitney
P.S. I welcome your feedback at WTDfeedback@empirefinancialresearch.com.