We hosted one of the best (and most important) webcasts we’ve ever done this week with key members of our team. It’s called, “The Mother of All Bubbles is Popping: Bank Failures, Contagion Risk & Coming Credit Event.”
If you haven’t watched it yet, you really need to…and here’s why: Our panel of market veterans thinks a “Minsky moment” is on the horizon.
“The rate of change of growth is slowing alongside the rate of change of inflation and therefore profits slowing, all at the same time” explains Hedgeye CEO Keith McCullough in this webcast. “That’s the very definition of #Quad4. That means the risk starts. That started 15 months ago. That’s not new.”
The thing that is new is the crowding into large cap Tech, despite the broad-based selloff in basically everything else in equities.
“Think of the Titanic.
You’ve seen multiple components go underwater in Tech. Then there’s VC, where you haven’t even seen them take their marks, so we don’t know how far they’ve sunk and where the bodies will surface.
Everyone else is cramming themselves up on the last part of the Titanic that hasn’t gone down. That’s called, MAGMA (Microsoft, Apple, Google, Meta, Amazon), plus Tesla and Nvidia..”
And that’s where the problems happen.
“By next week, we have 90% of public companies in the blackout period,” Keith continues. “Now they’ll have to report reality. #Quad4 is the shorthand for all this. We’re quite bearish, and I don’t think the intraday behavior, the bubbly behavior, reflects the bearish reality yet.”
That’s what makes the ongoing credit crunch in the banking sector that much more disconcerting. Think about it. There have been two big failures: Silicon Valley Bank is the $200+ billion in assets and 16th largest bank in the country; and Signature Bank with $110 billion in assets. Now the 14th largest bank, First Republic Bank (FRC), is being impacted by similar dynamics.
Here are some disconcerting stats from our Financials analyst Josh Steiner. Small and mid-sized banks are defined as any bank up to $250 billion in assets. (That’s anything outside of a top-10 bank in the U.S.) These banks collectively account for…
- About 50% of all Commercial and Industrial (C&I) lending
- About 80% of all Commercial Real Estate (CRE) lending
- About 60% of non-agency residential real estate lending; and
- 45% of all consumer lending
“We’re talking about a very significant portion of the banking system,” Steiner explains, “with system-wide you’ve got unrealized losses, as of year end, on held-to-maturity securities at $341 billion and on available for sale securities $280 billion. So combined, that’s $620 billion of year-end unrealized losses.”
In other words, as significant stress on the banking system continues to worsen, banks are likely tightening lending standards and causing additional economic issues.
“Trends in bank lending tend to feed on itself,” Steiner continues. “What that means is when lending standards are tightening, they create an economic slowdown, rises in unemployment, rises in business failure.”
And on and on the dominoes fall.
“That precipitates worsening credit quality, rising delinquencies, rising charge offs and that triggers further contractionary underwriting dynamics,” Steiner cautions. “And that system is an autocorrelated, reflexive feedback loop until it runs into a circuit breaker and that circuit breaker is typically the central bank.”
For those of you thinking, ‘Fed Chair Powell will come to the rescue…!’ Think again.
“What we heard from Powell is that that shouldn’t be expected any time soon,” Steiner goes on. “Yes, we’re nearing the end of the tightening cycle, but there’s no indication that they’re going to be easing and Quantitative Tightening is still in effect.” In other words, with very low unemployment and very high inflation, higher for longer is the Fed’s playbook.
“I think we’re approaching a Minsky moment right here,” explains Hedgeye’s new Director of Capital Allocation David Salem, a brilliant, 40-year industry veteran who started his career working alongside Jeremy Grantham at GMO.
Salem was on the phone with large-scale capital allocators this week, soliciting their insights on their current concerns at this momentous moment in the history of capital markets. One of Salem’s contacts, who he calls “one of the most successful venture investors of this generation,” told him that the coming mark downs in venture will likely be “way north of 35%.”
In other words—look out below.
We’ll leave you with this, Keith’s summation of the current market environment: “If you think there’s going to be a moment and we deny the fact that there’s a Minsky moment that’s already happening, I think we’re so far away from you in how we think about risk and the history of risk that’s linked to recessions that you’re not going to believe it. We don’t know how it’s going to end, but there’s the most debt and leverage in the system there ever has been, the most leverage in options market in history. In the history of ever, if somebody tells me that it’s just going to end because a bunch of stocks that everybody owns go up for a few more days, that’s great. But I don’t believe them.”
Bottom Line: Do yourself a favor. Watch the entire 58-minute webcast here.